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IMD 571 08.11.2012 INDUSTRIAL AND COMMERCIAL BANK OF CHINA: GOVERNANCE LESSONS FROM EAST TO WEST

IMD571

08.11.2012

INDUSTRIAL AND COMMERCIAL BANK OF CHINA:

GOVERNANCE LESSONS FROM EAST TO WEST

Professor Didier Cossin, Director of the IMD Global Board Center, directed the research that led to this case, which was written by Dr. Hongze (Abraham) Lu, Research Fellow as a basis for class discussion rather than to illustrate either effective or ineffective handling of a business situation.

An abridged version of this case is also available: IMD-1-0335 Industrial and Commercial Bank of China: The Governance Model.

Although we have received a multitude of governance awards globally, I believe there is no best corporate governance model. But bad corporate governance practices do exist and in some cases have led to corporate failures.

Mr Jiang Jianqing, chairman and executive director of ICBC.

What is the best corporate governance model? Although the path to modern governance had taken decades of strongly driven evolution, not to mention millennia of Chinese culture and history, Industrial and Commercial Bank of China (ICBC) had successfully combined modern Western models and structures with Chinese practices and culture into its corporate governance model. At a time of global crisis, could the governance efforts of one of China’s largest commercial banks inspire others around the world?

WTO Entry – “Openness-driven” Reform

Reform in China had been a long process. In 1979, at the beginning of China’s economic reform, Deng Xiaoping, a leader of the Communist Party of China, forged ahead with plans to transform “banks into real banks.” After 15 years of negotiations, China’s entry into the World Trade Organization (WTO) was approved on 10 November 2001. On 11 December it became the 143rd member of the WTO, showing outsiders the significant progress it had made in its efforts to integrate into the world economy.

WTO entry was expected to bring international competition to the Chinese market and induce “openness-driven” reform. A dramatic transformation of state-owned commercial banks (SOCBs) and state- owned enterprises (SOEs) would be required to increase efficiency. Since banking reforms had significantly lagged behind reforms in other sectors, at the time of the announcement, SOCBs faced enormous challenges, burdened with non-performing loans (NPLs) and mounting losses.

Copyright © 2012 by IMD, Lausanne, Switzerland (www.imd.org). No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means without the permission of IMD.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 2 - IMD-1-0327 Downsizing, Capability Building and Debt Restructuring Chairman Jiang had joined ICBC,

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Downsizing, Capability Building and Debt Restructuring

Chairman Jiang had joined ICBC, one of China’s “Big Four” SOCBs (and arguably the most prestigious), as a bookkeeper in 1979. Shortly before China’s entry into the WTO, he was appointed president and subsequently participated in the transformation of corporate governance in China’s banking sector. At ICBC, Chairman Jiang took charge of implementing the transformation strategy. Transforming a large, geographically dispersed and inefficient Chinese bank was a challenge. Due to historical reasons, management deficiency and lack of risk culture, the bank was broadly considered by international institutions and analysts to be “technically bankrupt,” with its NPL ratio reaching 47.59% by June 1999 (refer to Exhibit 1). There was little time to act: the banking sector was scheduled to be fully opened to foreign competition by 11 December 2006 and SOCBs would be required to complete shareholding reform and overseas listing by that time. The management team had to turn the bank around while competing with fast-growing local players and big global players (refer to Exhibit 2) in the planned five-year time frame.

ICBC stopped relationship lending by imposing severe punishment mechanisms. After 1999, the NPL ratio for newly added loans was 1.24%. Under the helm of Chairman Jiang, unprofitable branches and businesses were cut. In 1996 ICBC had had a workforce of 570,000 employees which continued shrinking to reach 360,000 in 2005. In this process, a performance-based culture was established, which involved the introduction of new

compensation plans and extensive training. Recalling his 11 years as president and chairman

at ICBC, Chairman Jiang said: “

with no means of retreating. We had to build a modern banking

system and implement changes with a very heavy hand.” This painful process and great

effort made it clear that state-owned banks were no longer ignoring efficiency.

At the same time, ICBC proactively enhanced its IT system and improved its electronic banking capabilities to support its overall business strategy. According to board member Mr Xu Shanda:

years. Make or break

first five years were the most difficult and painful

the

1

2

One of ICBC’s competitive advantages over competitors is its sophisticated IT architecture. ICBC was the first leading Chinese bank that had overhauled its IT infrastructure for data collection, analysis, processing, and management. It was designed to be client friendly and remained flexible to support enterprise risk management. ICBC is a big step ahead of other major Chinese banks, and a sophisticated IT system is the secret element of its advanced corporate governance. All the major Chinese banks have a similar starting point. Comparing with competitors, it is inaccurate to claim that ICBC has the most comprehensive set of codes, rules and working regulations, as we all face the same regulatory requirements. It is execution that makes all the difference.

In 2000 ICBC pioneered internet banking in the industry in China, and the online business experienced exponential growth year on year. In the past, ICBC had consistently received the “Best Internet Banking in China” award from Asian Banker. Due to the success of ICBC’s online banking services, Chairman Jiang was named one of the world’s 30 best online finance business persons by Institutional Investor. He was the only Chinese executive on the list. The new businesses and accompanying restructuring and downsizing reduced costs and increased profits. The latter were largely used to write off NPLs, which were estimated to decline by RMB 5 billion ($605 million) monthly.

1 “Break the cooking pots and sink the boats” is a Chinese idiom meaning to cut off all means of retreat so that fighting is the only way out. 2 Refer to Exhibit 9 for Mr Xu’s biography.

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at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 3 - IMD-1-0327 In implementing debt restructuring and shareholding reform, the biggest problem facing

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In implementing debt restructuring and shareholding reform, the biggest problem facing the bank’s management was the chronic capital shortage and NPLs. To increase capital and establish a sound corporate governance structure, the state initiated capital injection and shareholding reform in the banking sector. Bank of China (BOC) and China Construction Bank (CCB) received $22.5 billion each in 2003. ICBC, which was much larger, was expected to receive $50 billion. In 2005, surprising almost everyone, the capital injection from Huijin 3 was a smaller amount – $15 billion. The capital shortage was made up with the issuance of $12.1 billion in subordinated debt. After the capital injection, ICBC’s average capital adequacy ratio (CAR) reached 9.12%.

During this period, ICBC’s RMB 1,155 billion ($140 billion) NPLs 4 were greatly reduced. How did Chairman Jiang and his team manage the debt restructuring?

In 1999, China Huarong Asset Management Corporation (CHAMC) was established to buy RMB 407 billion ($49 billion) NPLs from ICBC.

ICBC pushed for collaboration with local governments. The bank grouped NPLs into sizable packages by region and negotiated with local governments, which backed the loans, to pay back a certain percentage of the total NPLs.

In 2003, CITIC Securities and Credit Suisse First Boston Corp (CSFB) helped ICBC design China’s first securitization deal of NPLs. Securitization made it possible to sell NPLs to investors.

In 2004, ICBC’s management reduced its NPL ratio to 21.16%, equivalently, RMB 785 billion ($95 billion).

In May 2005 ICBC sold RMB 246 billion ($30 billion) of NPLs at face value without recourse provisions to the asset management company CHAMC. A restructuring fund of the same amount was established with the Ministry of Finance (MOF) simultaneously. ICBC should generate income tax and pay dividends to the fund in the future to clear the restructuring cost itself.

In June 2005, ICBC auctioned RMB 459 billion ($57 billion) NPLs, divided into 35 packages to the four state-owned asset management companies. ICBC’s NPL ratio was reduced to 4.58%.

In July 2005, S&P adjusted the rating of long-term foreign currency bank deposits of ICBC from “BB+” to “BBB-”, and then re-adjusted to “BBB+” in September 2005. ICBC’s legacy NPL problems were finally resolved.

In 2005 ICBC ended the 10 years of meager profit. It began to pay back the loan from the restructuring fund, reaching RMB 14.969 billion ($1.85 billion) in the first year.

In March 2010, the restructuring fund was cleared, which meant the restructuring cost was paid off with asset appreciation, dividends and income tax paid. By the end of 2011, ICBC had contributed RMB 149.8 billion ($22.5 billion) to China’s fiscal income through dividend payouts to the state and income tax. 5

3 Central Huijin Investment Ltd. (Huijin), owned by the state council, was an entity established in December 2003 to represent the state’s assets in the banking sector. 4 Outstanding loan RMB 2,427.1 billion with NPL ratio of 47.59% in 1999.

5 In 2011, ICBC paid out RMB 70.86 billion in dividends of which 74.8% (RMB 53 billion) went to the MOF, Huijin and Social Security Fund. The bank also generated RMB 96.8 billion in income tax.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 4 - IMD-1-0327 Building an Effective and Responsible Governance Structure ICBC’s reform was a

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Building an Effective and Responsible Governance Structure

ICBC’s reform was a process of strongly driven execution underpinned by the evolution of an advanced corporate governance system, which reflected the four dimensions of effective board practices: 1) focused and dedicated individuals; 2) correct structures and processes; 3) quality information architecture; and 4) productive board dynamics. For Chairman Jiang:

When we built our governance system, we modeled it from that of some western companies. We learned from the best and worst examples; it was more difficult to integrate the learning into our own system to make it work. Learning and integrating are the sources of sustained, profitable growth. If you learn well but don’t know how to integrate that knowledge, you’re just a copycat. Integrating the elements you have learned into your system is more important than learning itself.

By incorporating this new knowledge into its existing system, ICBC put in place internal regulations including articles, rules of procedures for shareholders meetings, the functioning of the board of directors and supervisors and all the board committees. The processes ensured that the governance system would function efficiently in this unique environment. Chairman Jiang believed that while the Chinese approach to corporate governance (refer to Exhibit 4) was not perfect, it was the most satisfactory for ICBC’s circumstances and context, particularly given that the state was the largest owner.

The Shareholders

Building an effective and responsible governance structure started with the ownership reform of state-owned enterprises in 2005. Prior to this, ICBC had been fully financed by the state through the MOF. On 28 October 2005, ICBC was restructured as a joint-stock limited company, with the MOF and Huijin each holding 50%. In January 2006, ICBC brought in Goldman Sachs, Allianz and American Express as strategic investors. On 27 October 2006, the bank further diversified its ownership through simultaneous IPOs in Hong Kong and Shanghai.

After the IPOs, ICBC’s shareholders included Huijin and the MOF representing the state interest; Goldman Sachs, Allianz and American Express representing overseas strategic partners and institutional investors; and minority shareholders in Hong Kong and the mainland. The shareholding diversification reform was a historical stride forward compared with the state-ownership system of the past.

According to the Company Law, the shareholders assembly was the bank’s organ of power. It had the ultimate power to select directors and supervisors, set their compensation and decide on operational policies, financing, investment and dividend plans. Huijin and the MOF made the largest capital contributions and were therefore the majority shareholders. Under the new governance structure, they had the power to influence the management decisions at ICBC through their vote at the Shareholders Meeting or through directorial and supervisory board participation, as defined in the law.

The Board of Directors

The board of directors was the decision-making organ of the bank and was accountable to the shareholders general meeting. According to the rules of procedure, ICBC’s board of directors had to hold four regular meetings per year and be made up of 5 to 17 directors. ICBC chose to have 13 directors in 2005: 4 executive directors, 6 non-executive directors and 3 independent non-executive directors (increased to 6 in 2006).

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 5 - IMD-1-0327 In an interview with McKinsey, 6 Chairman Jiang expressed his view

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In an interview with McKinsey, 6 Chairman Jiang expressed his view on the board:

I see the board as the soul of a company. Sound corporate governance has a lot to do with a board’s structure, decision-making style and efficiency. The quality of the board’s members determines the board’s ability to perform its duties. A good board structure should be independent, professional, ethical, honest, and dedicated.”

Some time later, Chairman Jiang added:

Corporate governance makes us think of workplace democracy. Listening to more diverse voices when making decisions. Though some suggestions might be flawed, this mechanism generates beneficial effects and constitutes checks on power.

Mr Frank Wong, 7 one of ICBC’s board members, remarked:

Chairman Jiang has been one of the driving forces for change. When I joined the board, I thought it would be formal, rigid in a Chinese context. But it is not. One of the strengths of Chairman Jiang is that he is a seasoned banker and understands banking issues very well. In addition, he actually embraces change, is receptive to good ideas, and acts upon them quickly. If the ideas are not good, he will explain why he won’t use them at ICBC. I was quite impressed as that must come from somebody who understands the issues. He has been able to professionalize the board by bringing in talents, and effectively utilize talents and experience.

To bring distinct views to the board’s deliberations, ICBC created a rule in the early reform that at least three independent non-executive directors should sit on the board. The bank currently had six independent non-executive directors, accounting for more than one-third of the board. In October 2011, Mr Xu stated:

Serving as a member of the nomination committee at ICBC, I’ve been involved in the selection process. In my opinion, we should tap into three types of professionals: First, overseas experts with extensive work experience in the banking and finance areas. In this regard, we have Antony Leung, 8 Frank Wong and Kenneth Chung on board; second, academics, such as Professor Qian Yingyi, a seasoned expert in economics; 9 third, regulators, directly or indirectly related to the banking regulations in China or abroad. Malcolm McCarthy 10 once served as Chairman of the Financial Services Authority, and I’ve served as Deputy Commissioner of State Administration of Taxation. Personally, I believe this structure to be optimal as we have very diverse angles looking at all possible available alternatives. If we have only one type of independent non-executive directors, either banking professionals, academics, or regulators, the views will be rather narrow and possibly biased. Thus, the ICBC independent non-executive director framework is crucial for a balanced and efficient board.

6 Barton, Dominic, Yi Wang, and Mei Ye. “A Chinese view of governance and the financial crisis: An interview with ICBC’s chairman.” The McKinsey Quarterly, Iss. 2, 2009: 110–118.

7 Refer to Exhibit 9 for Mr Wong’s biography.

8 Independent non-executive director at ICBC (October 2005 to June 2012), the Chairman of the Greater China operations of Blackstone Group (China). He was the Financial Secretary of Hong Kong from 2001 to 2003. He was also Chairman of the Asia-Pacific Region of JP Morgan Chase Bank and worked for Citicorp.

9 Refer to Exhibit 9 for Mr Qian’s biography. Mr Qian Yingyi ceased to act as a director of ICBC as of August 24, 2012. He would be replaced by Mr Hong Yongmiao, Professor at Cornell University and Dean of the School of Economics of Xiamen University. 10 Refer to Exhibit 9 for Mr McCarthy’s biography.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 6 - IMD-1-0327 The independent non-executive directors did not represent any single shareholder and

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The independent non-executive directors did not represent any single shareholder and they were designated to make objective judgments and express unbiased views independently. Mr Antony Leung quoted a representative of one of the largest shareholders concerning the role of independent non-executives at ICBC:

“The reason that I want you guys to be there is to make sure that you can stop some lower level or kind of uninformed company official from asking ICBC to do stupid things.” That comment makes us a lot more comfortable in speaking up about anything that we believe is not right. We will not get appointed if we are not endorsed by the regulator and the major shareholders. As independent non-executive directors, we should focus on protecting minority shareholders. On the other hand, we also know that we are there because we are in a way approved by the majority shareholders. So we are there just to represent ourselves. I’m not a party member and I’m not mainland Chinese, I have to protect my own reputation and my name as a financial professional. We will say and do what we believe is right. We don’t need to get down on our knees in front of the chairman to protect our directorship.

At ICBC, the independent non-executive directors were able to speak their opinions and the management listened attentively. Mr Leung pointed out:

Chairman Jiang is willing to implement changes and he has the desire to take ICBC to truly

international standards. He will first ask himself if these opinions make sense and if they do, he

I admire his

leadership a lot. The management team headed by President Yang Kaisheng was quite willing to implement changes. In my last six years as an independent non-executive director, almost all the reasonable requests of the board members, certainly those from my side have been executed. Some might leave room for improvement, and some have exceeded our expectations. With a collective effort, I think ICBC is very different from the ICBC of six years ago.

will go ahead and make sure that proposals from directors are quickly implemented

The independent non-executive directors were part-time directors, but many of them were actively involved in the governance system. Mr Leung added:

The most important thing is not just participating in board meetings, but being willing and able to carry out business reviews with departments. Even after the initial IPO period, I would fly to Shanghai and talk to the head of private banking about their strategy, products, focus, for basically a day. They would prepare presentations with the format I like. Board members could meet any managers, usually by informing the board secretary first. The secretary and the board office would arrange meetings and sometimes accompany directors to provide logistics and take notes. The meeting minutes would go to the chairman and the president so they would be fully informed and communicated.

Apart from attending the board meetings, Mr Leung initially spent 25% of his time commuting between Hong Kong and Beijing, sometimes a few days per week, sometimes one day a week to meet with branch managers and other senior managers in major cities.

Other independent non-executive directors also became involved with management beyond what independent directors would do in a Western setting. Mr Wong explained:

Generally in a Western firm, you already have the structure and expertise. At ICBC, you do not usually have that structure ready. I would go and visit the department of global financial markets and sit down with managers for quite a long period of time, even raise questions and give suggestions for improvement. I also wrote papers of many pages to tell them what I thought would be the right things to do, and the areas of weakness. With written reports, it is easier for them to digest and share across departments. I wrote a paper on market risk and volume of trading. Chairman Jiang thanked me and wrote detailed comments. He then asked all the senior people to go through it, discuss it and implement what I suggested.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 7 - IMD-1-0327 The bank dictated that the executive directors from the senior management

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The bank dictated that the executive directors from the senior management team, who were considered as insiders, should not exceed one-third of all directors. Being members of the board, the senior management team and the party committee simultaneously, executive directors had multiple roles and responsibilities. The multiple roles distinguished executive directors from the other directors as they linked the board, the management and the party committee. Executive directors were involved in important decision-making processes in board meetings, and on the management and execution side, they periodically reported to the board about operating activities, provided the board with complete, accurate and timely information so that all members were fully aware of the bank’s operations. Mr. Yang Kaisheng, ICBC vice chairman, president and executive director said:

As the leader of the senior management team and president of the bank, I serve as the vice chairman of the board and an executive director. I report to the board about operating activities, attend every board meeting, and keep the communication lines smooth and clear. The board and the senior management team have developed an effective communication and co-working mechanism.

John Thornton, ex-president of Goldman Sachs and former director at ICBC (October 2005 to November 2008) observed many board meetings. He remembered:

In the case of ICBC – China’s largest commercial bank – a board meeting can feel almost more like an internal operating meeting than a Western board of directors meeting. So the topics of conversation, the level of detail and the honest interchange are quite impressive. There’s very little formality, and if directors have disagreements they argue it out right in front of you. 11

Regarding the level of detail at the board meetings, Mr Leung suggested that more work should be delegated to the management rather than taking it to board level. The board would then have more time to discuss strategy and direction, and monitor the implementation. Chairman Jiang strove to have more open discussions in the boardroom. He indicated:

We have board members who are in the management team. They focus more on the operational level details and you may call that a characteristic feature of our board meetings. Detail is the key to success, but an over-detailed board might neglect long-term or macro issues, which we must guard against. A Western board is more like a star-manager club, with board members focusing more on macro issues, long-term strategies that have fundamental impact on the company. It’s hard to judge which model is more effective and we strive to have a balance of the two models.

Unlike the independent non-executive directors, the non-executive directors – three from Huijin and three from the MOF – were full-time directors and representatives of the state’s investments. According to Mr Gao Jianhong, 12 officially the MOF directors were sent in the name of Huijin because as an organ of the government, the MOF could not directly send government officials to work as board members. After their term at ICBC, the MOF directors would return to the ministry and continue with their careers as government officials. The

11 Barton, Dominic, and Richard He Huang. “Governing China’s boards: An interview with John Thornton.” The McKinsey Quarterly, Iss. 1, 2007: 98–107. 12 Non-executive director representing Huijin (December 2008 to January 2012). Mr Gao previously served as the Vice Chief of the Finance Division of Macro-economic Control Department of the State Commission for Restructuring Economy, Vice Chief of the Investment Banking Department of China Development Bank and various other positions.

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at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 8 - IMD-1-0327 directors, who typically had no office space at the MOF, would

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directors, who typically had no office space at the MOF, would spend half a day a week at the MOF, briefing the major issues concerning the bank.

The MOF directors usually had no financial and banking experience, but usually had extensive experience working in various government agencies that were directly involved in steering the country’s economic reform. According to Mr Wong:

The non-executive directors representing shareholders are quite versed in the developments in China like the internal rules, regulations or future changes in policy. They know the meaning of implementation of a policy in the Chinese context. They offer their views from what they have seen on the ground, and also from the macro perspective and the Chinese perspective. They tend to look a lot more on the choice of words because the Chinese expressions to them are important. These are the areas they can contribute the most.

In general, the directors from Huijin came from diverse backgrounds such as the People’s Bank of China (PBC), China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC) or the Financial Affairs Leading Small Group of the Communist Party of China (CPC). Some of them, however, were recruited in the market. They usually received training and went through an examination process in order to qualify. When a board position became open at major banks, candidates would be shortlisted and selected. The Huijin directors spent one day a week at Huijin and the rest at the bank.

Although they did not hold management positions, the non-executive directors were committed to giving valuable views on major business decisions and the strategic direction of the bank. Assisted by a research team at ICBC and Huijin, the Huijin directors conducted in-depth studies on strategic topics. These reports were made available on the intranet and contributed significantly to a well-informed decision-making process at the board level. Mr Gao explained:

We fully support ICBC’s corporate strategy, namely, domestic expansion; global M&As; global talent recruitment; new ventures, such as ICBC leasing; fixed asset investment and annual budgeting.

Mr Wong added:

Directors from Huijin and the MOF also contribute a lot from the local perspective, such as credit exposure to a particular borrower, local government financing, provisions for the newly added loans, issues concerning fiscal stimulus or capital adequacy ratios. The evolving regulatory regime requires all the off-balance sheet items being recorded in the financial reports. This brings pressure on the capital adequacy ratio. When the bank needs more capital, shareholder representatives must get involved. On this part, the independent non-executive directors are not able to say much generally. We would speak from what we’ve seen, from the standpoints of risk management, credit provision, collateral, data, and evaluation, back testing, among others.

Mr Wong also highlighted the role of cultural issues:

Depending on the directors, I think we should be careful not to be senior people pushing, as

opposed to sharing. These are cultural differences of being humble. Humility is very important

and appreciated here board.

in terms of expression of views, it is no less than those in a foreign

But

John Thornton summarized his experience of working on the ICBC board:

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- 9 - IMD-1-0327 First, ask thoughtful questions and be willing to challeng e management

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First, ask thoughtful questions and be willing to challenge management in a constructive way. As I mentioned earlier, it is not that Chinese directors don’t do this. They do. Foreign directors, however, can bring a fresh and different perspective that is often extremely valuable. Second, they can leverage their experience and personal networks and serve as a window to the Western business world. Finally, having gained an understanding of China-unique issues and company culture, it’s important for them to be a catalyst for real change.

The Specialized Committees of the Board

ICBC’s board of directors was composed of six standing committees: strategy, risk management, audit, nomination, compensation and related party transactions control committees. The purpose of these committees was to provide assistance to the board in fulfilling its legal and fiduciary obligations. There were working regulations for each committee, including size, composition, duties, powers and meeting procedures. The board carefully elected the members of the committee to meet the legal and regulatory requirements in terms of qualifications and independence.

Of the six committees, five were chaired by independent non-executive directors. Chairman Jiang steered the strategy committee which held at least two meetings a year. In his opinion:

a dedicated person who knows the company well could create the best strategy. Keep close

contact with front-line employees and clients, and know their business needs, and then integrate the best available practices to your business to meet their needs. This practice is a must for scientific decision making and effective management in the bank. You have to know your business inside out to propose the actions that are right for the business. ICBC board has the ability to keep the right focus. We know what we have to do, what the major challenges are, what the right priorities are, and what we should achieve. When looking back in retrospect, we were glad that we made the right choices.

Other board members, however, were also involved in the process of formulating strategy and they made significant contributions. Mr Leung observed:

The board puts heavy weight on strategy. The chairman would organize a strategy retreat of at least two days once every two years, during which we reflected on the long-term strategy of ICBC. I remember that the management team once drafted a proposal to make ICBC the largest international commercial bank. Actually I disagreed with this statement. First, we should not just be a commercial bank. We should call ourselves a financial institution with various banking activities including investment banking. Second, we should not aim to become international, instead we should be global. Third, we should not aim to become the largest, but the most respected and influential. Last, we should also think about customers, to know their needs and meet their needs. In the end, the outcome was not exactly what I said, but quite close to it.

Mr Leung headed the risk management committee, which convened twice a year officially, as well as for special meetings called by the board. He noted:

When I first joined the board, I talked to risk managers and reviewed with them the audit report on risk management. Initially, they put in a report on the chapter bases. For example, credit risk as a chapter, then some other risks in different chapters. I asked if they could produce a total risk report and they looked astonished. Then, I sat down to talk about total risk management. I basically drew the format of the total risk management report. Writing on each column what I expected, and what should be on each row. I talked about how a total risk management should look.

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- 10 - IMD-1-0327 Through active interactions with the management, Mr Leung realized that it

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Through active interactions with the management, Mr Leung realized that it was necessary to give further training on risk management. He explained:

I introduced sensitivity risk analysis and stress testing. In the beginning, they didn’t have a clue what a stress test was. I gave them examples, and asked, if there were a trade war between the US and China, what would happen to ICBC? What would happen to our credit portfolio, to interest rates, to liquidity and what would be the secondary effects on the company? This has a lot to do with internal assumptions. Indeed, later, they successfully carried out the stress tests. CBRC, the regulator saw what ICBC was doing and introduced the practice to everybody. Now stress testing is a common practice in China.

He added:

I presented the framework of risk management to the senior management. I divided the topics into three sections: system and processes, people, and information. I particularly requested a total risk report and certain information in the financial reporting. If we present certain information in a predefined format, management will know the focus of the senior managers or directors. When they prepare a report with the format, they will automatically recognize if something is missing. In so doing, the board of directors has expressed their views on risk management and managers would automatically do something to manage the risk.

The audit committee reported to the board of directors and had ultimate responsibility for the auditing of the bank’s accounts. It held at least four meetings a year. Under this committee, the internal audit bureau had secondary reporting lines to both the senior management team and the board of supervisors. In this way, the senior management team was well informed about the results of the internal audit and the supervisory board ensured the completeness and objectivity of the work, thus evaluating the effectiveness of the bank’s controls. This double reporting structure ensured that the auditors did the work in an efficient and satisfactory manner.

Mr Xu explained:

As the chairman of the audit committee, I would say that we conduct thorough audits according to the law and no major misconducts have been discovered. From an income and expense point of view, the prudence concept at ICBC is among the best in China, which greatly enhances its capability to weather financial risk and turbulence.

The nomination committee, chaired by Mr Qian Yingyi, was responsible for the selection of top management. As stipulated in the working regulations, the duties and powers of the committee included:

Proposing candidates for directors, the president and the secretary of the board of directors;

Examining the candidates for senior management nominated by the president and making suggestions to the board of directors.

The nomination committee comprised eight directors, including five independent non- executive directors, two non-executive directors and one executive director. It held at least two meetings a year. While it was clear that the party’s decisions dominated senior management appointments, due to the composition of the committee, the independent non- executive directors could provide significant input before the board discussed any candidates.

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- 11 - IMD-1-0327 The compensation committee evaluated the performance of the bank’s directors, supervisors

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The compensation committee evaluated the performance of the bank’s directors, supervisors and senior management members and proposed compensation plans to the board of directors and shareholders general meeting. Like the nomination committee, the compensation committee consisted of eight directors, including five independent non-executive directors, two non-executive directors and one executive director. It held at least two meetings a year. Mr Qian was chairman of the committee.

The related party transactions control committee held at least two meetings a year. The committee was charged with formulating the basic policies, identifying and informing about the related parties of the bank, and approving those transactions. Mr Wong chaired the committee:

There was some work to be done when I took over. First, how do we define the related parties? As we have four direct regulators, CBRC, CSRC, SSE and SEHK, each has its own definition of related party. We need to harmonize the concepts so people can understand the rules concerning these areas. Second, how do we report to the regulators and receive approval on the related party transaction quickly. To be efficient, information must be correct. Third, the staff must understand the rules, regulations, definitions, so we have to offer more training. Fourth, how do we get people to be responsible? Overall, how do we implement the whole process?

He continued:

We defined three types of related parties. First M&A, for companies that we were interested in acquiring, we defined what percentage would constitute a connected party. Second, we needed to define the relationship between the bank and its subsidiaries. We enforced the arm’s length principle, so transactions have to be done at market rates. The third type was more diverse, including staff’s connections and relations with external parties. With the help of the legal department, we put all three types into a booklet with definition, system and process to manage the related party transactions. Regarding the system, I give credit to the chairman. We requested help from IT to enable management capabilities so that anybody working on related parties could input the transactions into the system right away and make reports online. As the bank is so big, we had to have a transparent, proactive process and training. With the system in place, it was easier to make people responsible for their inputs. In the end, we had a policy with harmonized rules, training sessions for staff at different locations, online reporting of the related party transactions and a mechanism to monitor the reporting and implementations.

The Supervisory Board

According to the rules of procedure, ICBC’s board of supervisors was “a supervisory organ of the bank, reporting to the shareholders general meeting, supervising financial activities, the board of directors, the senior management and members of the bank, and preventing them from abusing powers so as to safeguard the legitimate interests of the bank, its shareholders and the staff.” It was composed of five to seven supervisors including:

shareholder representatives; two external supervisors, who were elected by shareholders and who served a maximum of two consecutive terms; and representatives of the staff. The staff supervisors were elected by employees and accounted for at least one-third of the total number of board members.

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- 12 - IMD-1-0327 In 2012 the board of supervisors at ICBC was composed of

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In 2012 the board of supervisors at ICBC was composed of six supervisors. Mr Zhao Lin, 13 chairman of the board, had previously served as vice president of CCB and had an auditing and banking background. The shareholder representative supervisor, Ms Wang Chixi, certified public accountant, was appointed by the State Council as a full-time on-site supervisor. The two external supervisors were both professionals in the fields of finance and auditing: a certified public accountant and a professor of accounting. The external supervisors were not full-time and like the independent non-executive directors, they were expected to offer independent, unbiased views. The two employee supervisors were the general manager of the legal department and the deputy director of the trade union. Their role on the board was to ensure the fair treatment of employees. The supervisory board was composed of stakeholder professionals so that it could act independently from outside influence.

a

14

By attending shareholders meetings as non-voting delegates, ICBC’s board of supervisors was able to monitor the performance of directors and senior management, overall financial activities and auditing processes. Monitoring was based on several criteria, such as work attitude, behavior, capacity to fulfill duties, contribution, and so on. According to Ms Wang:

Supervisors have full authority and the highest level of access to information or materials. We carry out periodic inspections on risk management, internal control or related party transactions, and if necessary, require detailed explanation to dig deeper into any suspicious issues. We normally require four to five briefings by the external auditors on financial status such as asset situation, loss allocation, asset quality, risk exposure or any other operational issues. We might also question the process of a decision, for example, who and why signed off the decision.

In addition, retiring and leaving directors, presidents and other senior management members had to undergo an auditing process by the board of supervisors. Any issues relating to laws and regulatory requirements were brought to the management team and the board of directors through deliberated motions. If the board of supervisors failed in its supervising and inspection duties, it would be summoned to hearings by CBRC.

To outsiders, the role and mandate of the board of supervisors could seem unclear. Mr Leung described his first impressions of the board:

Initially I didn’t understand why we should have supervisory board alongside the board to manage and govern the bank. Later on, I found that the supervisory board is quite useful and having it might not be a bad thing. Its role is to monitor the board and the board members. In a Western board, you don’t have such an institution. In the Western corporate governance system, sometimes, but not always, the CEO appoints the members of the board, so it becomes compliant with the CEO’s disposition. In the Chinese system, the supervisory board provides checks and balances by law.

With regard to the work process, Mr Leung explained:

13 From a governance perspective, the board of directors and the board of supervisors run in parallel under the shareholders assembly. 14 Ms Wang had taken several positions including vice chief of the Financial Audit Department and deputy director of the Agricultural, Forestry and Sea Products, Audit Bureau of the National Audit Office, and full-time supervisor at the Agricultural Bank of China.

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- 13 - IMD-1-0327 They don’t normally participate in board discussions. On the other hand,

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They don’t normally participate in board discussions. On the other hand, because they are really full-time people, they can help the bank focus better on strategic management with motions. Again, this depends on the quality of the supervisory board members. I remember that some of them would actually point out areas that even board members failed to identify, because independent directors are part-time, and shareholder directors do not have enough banking experience. The supervisory board members actually have the advantage of stability, expertise and experience. So having full-time people watching out is a big plus.

Ms Wang also noted:

In my opinion, the best practice of the board of supervisors rests with major banks. With strict execution, highest level authority, a mixed full-time and part-time professional team, the board of supervisors can constrain and prevent misconduct and abuse of power. The board of supervisors is an indispensable force to improve corporate governance.

The Senior Management Team

The bankers at ICBC were among the lowest paid in the world according to a Reuters survey. In 2008, Chairman Jiang earned $234,700, which was less than 2% of the $19.6 million awarded to Jamie Dimon, CEO of JPMorgan Chase. “That’s basically nothing for the leaders of these huge Chinese financial institutions,” said Laura Thatcher, who led the law firm Alston & Bird’s executive compensation practice in Atlanta. “I can’t imagine why they would work for nothing.” 15 Why would Chinese bankers accept such low salaries?

Top Chinese bankers are party members who were recruited when they were young for their merits and ethical behavior. Through their careers, they were trained to pursue noble causes, even if sometimes it meant some self-sacrifice. Thirty years after the economic reform, most ICBC managers had participated in the great economic reform that transformed China. It was undeniable that ICBC managers had the desire to turn the bank into a world class competitor, as this was definitely a once-in-a-lifetime opportunity for them to demonstrate their capabilities and to be remembered in history. For these reasons, they were willing to embrace change, and accept tight monitoring and low salaries. Mr Leung remarked:

In the last six years, one of the most contended issues has been compensation. The MOF and Huijin, in a way, propose what the pay level should be for the chairman and other senior managers. Obviously, if we just look at the performance of ICBC itself, we believe that the management should get a higher salary. Although we have the independent non-executive directors, such as Professor Qian Yingyi and me, the votes from shareholder directors would carry more weight. The management remains underpaid.

Mr Gao Jianhong, a Huijin director, noted:

We agree that the pay level of senior management at ICBC is significantly lower by international standards. However, we must confront the reality that China is a developing country where the average income level is low by any international measures. The CPC calls for strategies to reduce the gap between rich and poor, and we could not go the opposite way widening the gap. We must maintain a socially responsible corporation.

15 http://www.reuters.com/article/2009/09/23/us-compensation-exclusive-idUSTRE58M2QU20090923.

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- 14 - IMD-1-0327 Mr Liu Mingkang, chairman of CBRC, favored appointing overseas executives to

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Mr Liu Mingkang, chairman of CBRC, favored appointing overseas executives to senior positions such as CFO and CTO at the Big Four, which was a bold and unprecedented suggestion. Hiring external executives would fill capability gaps and increase credibility. Mr Wong observed:

Recruiting talents and adequate compensation would lead to a quantum jump. We have hired a new vice president from Deutsche Bank. The compensation is close to those of the other senior managers, but the appointment of overseas executives is a big change from what we have seen before.

Senior managers could be promoted beyond what a bank could possibly offer. A top executive might become a governor of a province or a regulator supervising an industry. The opportunities were considerable and could always provide career advancement as incentives for performance. For many senior managers, the value of career advancement could far exceed higher pay. But it would be naive to believe that higher positions would come easily. The competition was fierce and senior managers had to demonstrate their management capability, impeccable ethical merits and networking skills.

16

Senior managers were also tightly controlled with clear-cut power and responsibility. The bank had a strict authorization process. President Yang said:

At ICBC, we have a clear authorization culture, and we prohibit all unauthorized practices. As we usually say, “it is not allowed to do evil beyond one's authority, and it is not allowed to do good without being authorized.”

Internal controls included the independent non-executive directors on the board, the board of supervisors, the party committee and the party disciplinary commissions. 17 External controls included regulatory mechanisms from CBRC and legal supervision including civil penalties. There were always greedy managers who pursued personal interests with positions of power or the bank’s money. Unethical behavior was severely punished. Criminal charges, such as taking bribes and abusing power, could lead to confiscation of possessions and even the death penalty.

The Communist Party Committee at ICBC

At the end of 2011, the CPC had over 82.6 million members, equivalent to 6% of the total

population of mainland China. Party members were recruited on the grounds of merit, with

capability

as a plus. 18 Traditionally, the party articles empowered the party committees to

lead all the SOEs and all levels of government in China. In 2007, the Constitution of the

Communist Party of China was amended.

The amendments stated that leadership by the

party meant mainly political, ideological and organizational leadership and its activities

19

16 Example: Su Shulin, current governor of Fujian Province (former Chairman of Sinopec) or Guo Shuqing, current chairman of the CSRC (former Chairman of CCB) .

17 Senior managers such as Chairman Jiang and president Yang Kaisheng were monitored by higher level organizations, such as the Central Discipline Inspection Commission and the Ministry of Supervision.

18 In Chinese , . Merit: morality or ethical behavior which is characterized by honesty, responsibility, fairness and equity. Capability: specific qualifications or technical skills.

19 At the Seventeenth National Congress of the Communist Party of China on October 21, 2007.

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- 15 - IMD-1-0327 should fall within the framework of the constitution and laws of

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should fall within the framework of the constitution and laws of the country. The Company Law 20 formally transferred the decision-making power to the boards of directors. In some SOEs, the management team, the board of directors and the board of supervisors were infused with party members, the party committee and the party disciplinary commissions. This practice inherited the party-centered structure and brought no fundamental changes in the corporate governance system.

The Communist Party committee at ICBC remained a latent part of the governance structure. At ICBC, Chairman Jiang synergistically served as party secretary and chairman of the board of directors. He proposed that the party committee should fully support the board of directors and the management in decision making, lawful operation and efficient execution. The directors who were also party members should express their opinions as directors at the board meetings. Through this process of consultation and participation, the party committee became a key stakeholder in the bank.

Under the new governance structure, the party committee remained at the political center of ICBC. As such, it voiced opinions on the key business decision making, including senior management appointments, ensuring that corporate decisions took into account national policies, guidelines, regulations, providing essential support of management decisions and maintaining stability. According to Mr Leung:

Alongside the structure we all know who the real decision maker is; that is, the party. The party is usually silent. However, if necessary, the party would prevent certain problems that occur in the West; for example, if the board becomes the rubber stamp of the CEO. So working with the party presents its challenges; but it also prevents certain problems.

Outsiders often questioned the role of the party committee in the senior management selection process, since the party’s choice might be driven by ideology, which could be in conflict with market-orientated corporate governance mechanisms. However, the party committee was formally assigned with the task of safeguarding the interests of the firm, which is no different to the board of directors’ task. At lower levels, the party committees in the bank’s branches also had similar consultation mechanisms. The party-member job candidates had to be competitive in terms of technical expertise and play the pioneer and role model in terms of service excellence. They had to win their position through an open, fair and transparent process. Javed Hamid 21 admitted:

When the government is the largest shareholder in a bank, there is no question that it should drive the selection of the chairman and top management. In the initial phase of investments into the banking sector, in which IFC has taken part, our experience has been that the interests of existing majority shareholders and the new investors have largely been very similar.

John Thornton, who also served on Netcom, a Chinese SOE, recalled:

The chairman of Netcom likes to say that he does not see a contradiction between party influence and the protection of minority shareholders because the goals of the two are the same

20 The Company Law of the People’s Republic of China, 27 October 2005. Article 19: In companies, Communist Party organizations shall, in accordance with the provisions of the Constitution of the Communist Party of China, be set up to carry out activities of the Party. Companies shall provide the necessary conditions for the Party organizations to carry out their activities. 21 Hamid, Javed, director, East Asia and the Pacific, IFC, speech, Corporate governance and banking reform in China, China International Finance Development Forum 2005.

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- 16 - IMD-1-0327 – namely, Netcom’s success as a business. No one wants Netcom

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– namely, Netcom’s success as a business. No one wants Netcom and all the other state-owned enterprises to succeed more than the Chinese government and the Communist Party do, because the success of these businesses will better allow the party and government to tackle the myriad of problems the country faces

The party’s disciplinary function ran parallel with the function of the board of supervisors. According to the Company Law and the bank’s articles, the function of the board of supervisors focused mostly on the board of directors, the senior management team and financial reports. The party committee and its disciplinary commissions operated at various levels of the bank. The full-time disciplinary inspectors provided thorough monitoring from the top to the bottom. Party monitoring prevented misconduct by lower level managers and improved corporate governance.

The management system at ICBC made two-way communication possible. Top management was able to make decisions on the available data, and lower managers were able to react quickly to meet their goals. In addition to the management system the party had established separate channels for information flows. Through regular meetings, the party’s opinions were disseminated among every party member of the bank, and the opinions of the workers’ union, staff and workers were summarized and presented to the top party committee, the board of directors and the management team. A separate party channel could provide more information for better decision making than would otherwise be available.

The party channel and membership constituted a stable and strong force in implementing drastic changes and resolving conflicts of interest. Through party loyalty, the banking reforms initiated from the top faced lesser resistance at the bottom. Many bank employees were party members who were assigned the responsibility of implementing changes and maintaining stability. Consequently, the cost of reform was significantly reduced.

It seemed unlikely that the party would withdraw completely from the decision-making process, especially concerning recruitment and the evaluation of large banks. As previously observed in some SOEs, the party committees tend to meddle with the board of directors and thus have a negative effect on firm performance. ICBC showed a different route, leveraging the potential of the party in communication, monitoring, execution and decision making, which had a positive impact on firm performance. The existence of the party committee at ICBC was not a window-dressing device, it generated real impact on firm performance.

Strategic Investors

Why did the state bring in strategic investors despite having its large foreign reserves? The government viewed it as a major step in the banking reform, not because of foreign investment, but because it provided the basis for a new governance concept and better internal governance structures, and for improved business models, advanced techniques, innovative products and new banking technologies. Moreover, being associated with well- known foreign brand names could help with the shareholding reform and the IPOs scheduled for the near future. Huijin was receptive to the idea that with a 5% stake, a foreign strategic investor could nominate a director; with a 10% stake, a foreign strategic investor could nominate two directors and one member of the management team.

In January 2006, ICBC established a non-exclusive strategic cooperation with Goldman Sachs, Allianz and American Express. The three companies took an 8.45% stake with about $3.78 billion in the joint-stock bank. ICBC’s projects with Allianz and American Express focused on specialized areas such as insurance and credit cards. Although foreign strategic investors had had mixed experiences working with Chinese banks, the strategic cooperation projects between ICBC and Goldman Sachs worked as planned.

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- 17 - IMD-1-0327 Goldman Sachs agreed to provide technical assistance, consultation and employee training

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Goldman Sachs agreed to provide technical assistance, consultation and employee training to ICBC, to develop non-lending products and risk-aware corporate culture, and to improve the risk management system and the corporate governance structure. The strategic cooperation agreement identified seven areas of strategic cooperation and assistance: corporate governance, risk management, treasury business, asset management, corporate and investment banking, non-performing loan disposal and training.

In the corporate governance area, Goldman Sachs provided its code of corporate governance and best practices of corporate governance. ICBC was thus able to improve its internal

including new

process design and implementation details. In the risk management area, Goldman Sachs made recommendations including establishing an efficient system of internal reports, creating risk frameworks for credit, market and operational risk in line with Basel II, and drawing up codes for a risk management committee. In the treasury business area, ICBC and

auditing and reporting systems in accordance with the new IFRS standards,

22

Goldman Sachs jointly developed RMB notional structured investment products linked to foreign currency derivatives. Regarding the disposal of non-performing loans, Goldman Sachs advised on the individual approach and the portfolio approach.

As part of its strategic assistance, Goldman Sachs sent three experts to work as full-time consultants at ICBC. The knowledge transfer went further. Goldman Sachs agreed to assign at least 50 of its personnel as senior advisors dedicated to providing training and technical support to ICBC, and conducted at least 50 training sessions on key business areas. In addition, ICBC would nominate at least 50 senior executives to attend a Goldman Sachs leadership development program and at least 50 employees to attend training programs for periods of three to six months at Goldman Sachs headquarters or other locations in key business areas.

The cooperation details between Goldman Sachs and ICBC showed that the bank did take this opportunity seriously to improve corporate governance and enhance capability. The frustrations that had been experienced by some strategic investors with other Chinese banks proved that changes occurred at different rates in each bank.

Long before the IPOs, Chairman Jiang and his ICBC team launched several reform initiatives such as downsizing, building profit-generating capabilities and debt restructure. After the initial reform, ICBC diversified its ownership with Huijin, the MOF, Goldman Sachs, Allianz and American Express as investors. The bank appreciated the value of transparency and planned to reach higher levels of corporate governance. Equipped with an efficient and well-composed board of directors, board of supervisors, committed senior management team, strategic investors and a delicate balance with the party committee, ICBC was ready for its mega-IPO.

Dual IPO and Continuous Improvement of Corporate Governance

ICBC’s public listing was a check on the status of the bank’s governance and an effective way to induce it to improve governance even further. The bank would be required to attain higher standards of information disclosure and would be strictly monitored by diverse shareholders, more regulators and other related parties. Going public was a necessary step to transform Chinese banks into competitive banks.

22 International Financial Reporting Standards (IFRS) were principles-based standards, interpretations and the framework adopted by the International Accounting Standards Board (IASB).

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- 18 - IMD-1-0327 On 27 October 2006, ICBC had simultaneous IPOs on the Hong

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On 27 October 2006, ICBC had simultaneous IPOs on the Hong Kong Stock Exchange (SEHK) and the Shanghai Stock Exchange (SSE) respectively. With 76 times oversubscription, ICBC’s HK IPO retail tranche attracted the largest amount of orders ever. Given the strong interest, ICBC priced its shares at the top end of the range specified in its prospectus. The bank sold 35.39 billion “H” shares in Hong Kong and 13 billion “A” shares in Shanghai. After exercising the over-allotment option on 19 November 2006, ICBC raised $21.9 billion, making it the world’s biggest IPO. 23 Mr Wong stated:

One thing that I like particularly in SOEs such as China Mobile and ICBC, is the use of independent external auditors extensively. This really has helped the independent directors to work much easier. As ICBC is listed in Hong Kong and Shanghai, the accounting standards are in conformity with both international accounting standards and Chinese accounting standards.

Listed companies are required to provide more protection for minority shareholders. After the IPO, the ICBC board composition changed and the number of independent non-executive directors grew to six, which was expected to better protect the rights of minority shareholders. The independent non-executive directors had diverse backgrounds, such as economics, financial markets, taxation, regulations and auditing. Mr Wong noted:

The board accountability comes from the regulators. The board itself increased its number of independent directors in the last two years. Now we have six independent non-executive directors with different experiences and backgrounds to professionalize the board and enhance its set of skills.

ICBC also developed new mechanisms to interact with a wider range of investors. It built new investor communication platforms and offered extensive information on its website. It encouraged investors to attend shareholder meetings and vote on major issues. When holding

the annual meetings, the bank set up video connections between Shanghai and Hong Kong, to make it easier for domestic and overseas shareholders to participate. Following the meetings, the bank held the performance release conferences. In 2007, ICBC hired McKinsey to identify gaps between international best practices and ICBC’s actual practices, and to design solutions to address the problems of its governance structure, including investor relationship management. Best practices were adopted after McKinsey’s review. ICBC was highly commended by global investors for its efforts and consistently received

“Best Investor Relations Company”

24

awards.

During the IPOs, ICBC’s improvement in its governance was hailed a success by the market. It also helped with the continuous improvement of the bank’s operating performance. From 2006 to 2010, ICBC’s net profit achieved a compound annual growth rate (CAGR) of 35.1%; this rate brought it among the top performers globally in the period. Return on assets and weighted average equity increased from 0.71% and 15.37% to reach 1.44% and 23.44% respectively in 2011. In the same period, ICBC increased its assets from RMB 6.46 trillion ($0.8 trillion) in 2005 to RMB 15.48 trillion ($2.46 trillion) in 2011. In 2011, its NPL ratio reached a historical low level of 0.94%, and despite a fast-growing asset base, its CAR reached 13.17% (refer to Exhibits 5 and 6), representing significant improvement over the 2.38% CAR at the beginning of the shareholding reform.

23 The record was surpassed by the Agricultural Bank of China IPO in 2010, the last of the Big Four to go public. 24 The award was given to publicly traded companies on their excellence in managing investor relations, bearing in mind the interaction between senior management and their investors, the timeliness of responding to shareholders’ opinions and website coverage.

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- 19 - IMD-1-0327 After the third quarter of 2007, ICBC continued to be ranked

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After the third quarter of 2007, ICBC continued to be ranked as the largest bank in the world by market capitalization, customers’ deposits and profitability (refer to Exhibit 7). The improved performance was reflected in the 2011 Edelman trust barometer report. Banks in the US could not recapture the public’s trust, while Chinese banks significantly gained trust. ICBC’s brand image of “By Your Side and as Your Trust” acquired wide recognition. In addition, the bank’s corporate governance model obtained widespread recognition by global and local investors. It won numerous awards including “Best Bank in China,” “Best Corporate Governance,” “Best Bank for Performance of Corporate Social Responsibility,” and “Best Corporate Citizen in China” (refer to Exhibit 8). Executive directors at ICBC had also been widely recognized for their commitment, capacity to fulfill duties and operating performance. In 2011 and 2012, Chairman Jiang and President Yang, as ICBC executive directors, received “Asian Corporate Director Recognition” awards respectively from Corporate Governance Asia. President Yang Kaisheng received the “Most Valuable CEO” award from MoneyWeek twice. 25 ICBC aimed to become a global leading bank with the best profitability, performance and prestige. According to Mr Gao Jianhong:

The bank reform in China started ten years after the SOE reform in China. As a latecomer reform, banking reform could take advantage of the experiences transforming the real sector, such as oil and energy. Many SOEs probed IPOs with part of the company’s best assets, and left parent companies with debts, unpaid pension holes or redundant employees. The SOEs reform created chronic problems that would only dissipate with time and continuous reforms. In contrast, all major banks had full IPOs in different jurisdictions, they established boards of directors and supervisors, and most importantly, set an example of how to incorporate the state as investor and regulator.

Chairman Jiang summarized such a transformation:

Going public brought in more stakeholders and enhanced outside control which required us to have a complete corporate governance structure, new operations structures and higher standards of information disclosure. These are powerful engines for ICBC. As a public company, we continued to reform, perfect our governance system to attain higher goals.

China’s banking reform has been a continuous process. Without downsizing, debt restructure and capability building in the past, ICBC would not have been restructured into a joint-stock limited company; without joint-stock restructure and going public, ICBC would not have got rid of the historical NPLs and built its modern corporate governance structure and system; without continuous reforms and innovation as a public company, history (bad loans) could repeat itself, as governance itself should be continuously improved. The IPO did raise some money as designed, however, as an old Chinese saying goes, the arduous task (of corporate governance improvement) is still an uphill journey.

Future Governance Transformation and Strategic Direction at ICBC

Mr Leung stressed the importance of the role of independent non-executive directors for the process (refer to Exhibit 9):

I hope ICBC continues to bring in independent non-executive directors who have deep banking experience. Both quantity and quality of independent non-executive directors are important. It isn’t just the name, but name, experience and time. Banking is a very specialized kind of

25 MoneyWeek, , an influential weekly investment magazine in China.

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- 20 - IMD-1-0327 institution and without decades of experience, it is difficult to significantly

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institution and without decades of experience, it is difficult to significantly contribute. It is a good strategy to appoint people who have more time in their hands, especially the retired banking professionals. They have experience, preferably work experience with international banks that can be shared. We have Kenneth Chung who has experience as senior partner in the auditing firm PWC, we have Malcolm McCarthy who was the head of FSA in the UK, and Mr Frank Wong who has decades of banking experience on market risk.

Experience makes a difference, particularly in difficult times. If you have served in financial institutions for decades, chances are that you went through at least three or more financial crises. I went through nine crises in various capacities. When you have people with such experiences and maturity, they could help management a lot as management are probably not as senior as directors. Sometimes you have to live through a crisis in order to manage it better. I’m confident about the performance of the board in good and bad times and, in addition, I think we are lucky because China Inc. has plenty of resources.

Mr Leung also expressed hopes for the full-time non-executive directors:

We should also ask directors to be more involved. On the ICBC board, we have non-executive directors who are shareholder representatives. It would be great if they had relevant banking background to make a difference. Usually they serve a three-year term on the board and it is a pity if they have to depart after acquiring the necessary banking knowledge to make significant contributions.

When asked if he considered ICBC as a governance benchmark in China, Mr Leung replied:

Indeed, no hesitation. At least among the largest banks, ICBC is the best-run bank. Among the people in the financial sector that I have talked to, they all think ICBC is the best governed and managed.

ICBC is in the process of a transformation that leaves ample space for expansion. According to Mr Xu:

First, geographically. ICBC focuses mainly on China, and so its overseas business is limited. Although limited exposure to the global banking industry shielded it from the 2008 financial crisis, the bank should take advantage of the opportunities in other countries. ICBC has developed a uniformed core business system. The software package would allow fast deployment of the overseas business system. With the growth of business outside of China, the governance system is likely to evolve accordingly.

Second, ICBC’s operating income mainly comes from net interest, the traditional borrowing and lending. Net fee and commission income constitutes only one fifth of the total income. The bank sees growth potential in the fee and commission generated businesses, including insurance and investment banking. The corporate governance structure will change when the nature of the business changes. ICBC should invest resources today to lay the foundation for future growth.

In light of future expansion, Mr Wong could envisage further changes:

As the bank operates more in overseas markets, it will acquire more international practices. The board will spend more time discussing strategies on overseas expansion. In the past, we extensively discussed the transformation of the bank, risk management and issues related to China. I do believe when we become global, the discussion will be more focused on overseas markets. This is what I consider would move the board forward.

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- 21 - Chairman Jiang commented: IMD-1-0327 When discussing strategic directions, ICBC has a long-term

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Chairman Jiang commented:

IMD-1-0327

When discussing strategic directions, ICBC has a long-term horizon of five years, ten years or longer. This might differentiate us from other banks. Running a bank is like running a marathon. We keep up stamina and move ahead with a balanced pace. At a certain point, we noticed that competitors were left behind as they kept changing directions in the course. We don’t expect to hear applause after the first 100 meters, 1,000 meters, or even 10,000 meters. Instead, we should focus on our target and direction, and on becoming fully devoted, and remain on track to be the first to reach the finish line. The banking marathon has lasted for hundreds of years and many runners have disappeared from the tracks. The champion is yet to be known, and we are one step ahead.

Potential Inspiration for Western and Emerging Markets

The 30 years of reform of China’s banking sector was a snapshot of the reform within the country, which had evolved by trial and error in exploring new paths for development (refer to Exhibit 10). China’s publicly traded banks learned to focus on customers, and acquired a stakeholder-oriented corporate governance approach. In China’s unique environment, ICBC effectively integrated elements of Western governance into its system (the hierarchical structure from shareholder meetings to the board of directors, the decision processes on the board, the presence of independent directors, the role of committees, etc.) while developing its own, unique path.

ICBC’s governance practices were a good illustration of the experience of the banking sector during China’s economic transformation and constituted a solid foundation to move forward. The reform process evolved in a particular and unique way adopting elements learned outside as well as inside China. Chairman Jiang noted:

Sound corporate governance practices are the key to the stability of the banking sector, or perhaps of the whole financial system; those practices determine how fast and how far a bank moves forward, and are the foundation of sustained, profitable growth of any corporation.

Corporate governance had been challenged in the West, particularly in the wake of the 2008 crisis, when it became evident that decisions taken at the top of organizations were not always optimal. In addition to the independent directors’ checks and balances on the board and the presence of full-time non-executive directors, public companies in China had two further control mechanisms. The board of supervisors was tasked with monitoring the performance of the board members and senior managers, and the party disciplinary commission checked on the performance of lower level management. The supervisory board’s role was unique and the role of the party disciplinary commission stemmed from the political system, which might not be applicable in the West, supporting the premise that there is not a “one size fits all” solution to corporate governance issues.

The ownership reform in China limited the state’s role as owner in companies to one more akin to that of an investor. ICBC’s sustained profitable growth, which contributed to the country’s economic development, was strongly tied to its governance system. James Wolfensohn, former president of the World Bank, once commented, “The governance of the corporation is now as important in the world economy as the government of countries.” And as the world looked into improving its corporate governance practices, the question was, how could China’s success, and more specifically ICBC’s success in transforming its governance, inspire others around the world.

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- 22 - IMD-1-0327 Exhibit 1 ICBC’s NPL Ratio and Outstanding Loan Balance Source: ICBC

- 22 -

IMD-1-0327

Exhibit 1 ICBC’s NPL Ratio and Outstanding Loan Balance

Exhibit 1 ICBC’s NPL Ratio and Outstanding Loan Balance Source: ICBC History (ICBC), ISBN 978-7-5 049-4867-0,

Source: ICBC History (ICBC), ISBN 978-7-5049-4867-0, ICBC Annual Report 2011

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- 23 - IMD-1-0327 Exhibit 2 The Declining Market Share of State-Owned Commercial Banks *Includes

- 23 -

IMD-1-0327

Exhibit 2 The Declining Market Share of State-Owned Commercial Banks

The Declining Market Share of State-Owned Commercial Banks *Includes policy banks, rural commercial banks, rural co-op

*Includes policy banks, rural commercial banks, rural co-op banks, urban co-op banks, foreign banks, leasing companies, postal savings

Source: China Banking Regulatory Commission (CBRC)

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- 24 - IMD-1-0327 Exhibit 3 ICBC’s Technology-Oriented Strategy ICBC was the first bank in

- 24 -

IMD-1-0327

Exhibit 3 ICBC’s Technology-Oriented Strategy

IMD-1-0327 Exhibit 3 ICBC’s Technology-Oriented Strategy ICBC was the first bank in China to realize central

ICBC was the first bank in China to realize central storage and uniformed processing of data across the whole bank, and to set up an integrated system of production, disaster backup and testing.

Processing capacity significantly increased, with daily business volume reaching 110 million and ensured the normal conduct of business services

Safe and stable operation platform for information systems

Powerful core

Powerful core ICBC was the first bank in China to develop a uniformed core business system:

ICBC was the first bank in China to develop a uniformed core business system: NOVA. This expedited the development and extension of the overseas business system (FOVA).

Drove the fourth-generation application system (NOVA+) to create an application framework with more flexibility, cutting edge, high performance and risk resistance.

business

processing

systems

Sound IT

Sound IT The information technology management system was further improved to form a more complete information

The information technology management system was further improved to form a more complete information technology management framework consisting of operations management, project management and general management.

Improved the technical specification, and achieved a technical specification system framework covering seven major categories.

management

system and

technology

criteria

 

Sound

ICBC paid close attention to the protection of intellectual property rights, and owned 106 patent rights as at the end of June 2009.

information

technology talent

team

of June 2009. information technology talent team ICBC owned the largest team of technology talents in

ICBC owned the largest team of technology talents in the Chinese banking sector. It researched and developed 384 new projects in the first half of 2010.

Source: ICBC company presentation, 2010

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- 25 - IMD-1-0327 Exhibit 4 ICBC’s Corporate Governance Framework Source: ICBC 2011 annual report
- 25 -
IMD-1-0327
Exhibit 4
ICBC’s Corporate Governance Framework
Source: ICBC 2011 annual report

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- 26 - IMD-1-0327 Exhibit 5 ICBC Financial Results (2007–2011) Source: ICBC 2011 annual report

- 26 -

IMD-1-0327

Exhibit 5 ICBC Financial Results (2007–2011)

- IMD-1-0327 Exhibit 5 ICBC Financial Results (2007–2011) Source: ICBC 2011 annual report This document is

Source: ICBC 2011 annual report

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- 27 - IMD-1-0327 Exhibit 6 ICBC Financial Ratios (2007–2011) Source: ICBC 2011 annual report

- 27 -

IMD-1-0327

Exhibit 6 ICBC Financial Ratios (2007–2011)

- IMD-1-0327 Exhibit 6 ICBC Financial Ratios (2007–2011) Source: ICBC 2011 annual report This document is

Source: ICBC 2011 annual report

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- 28 - IMD-1-0327 Exhibit 7 ICBC Customers and Market Capitalization Corporate Corporate Customers Cash

- 28 -

IMD-1-0327

Exhibit 7 ICBC Customers and Market Capitalization

Corporate

Corporate Customers Cash Management Customers Corporate Internet Banking Customers

4.37 million 747 thousand 2.96 million

Individual

Individual Customers Individual Internet Banking Customers

292 million 130 million

Electronic Banking

E commerce online payment transactions volume Self service Banks Automated Teller Machine (ATM)

RMB 372.817 billion

15,300

63,900

Source: ICBC company presentation, end of 2011

250

200

150

100

50

0

The World’s Largest Bank in Terms of Market Capitalization (Bloomberg, 30 December 2011)

228.046 174.814 in $ billions 145.338 136.077 135.524 126.342 121.444 79.815 76.923 74.722
228.046
174.814
in $ billions
145.338 136.077 135.524 126.342 121.444
79.815 76.923 74.722
136.077 135.524 126.342 121.444 79.815 76.923 74.722 Source: ICBC company presentation, (Bloomberg, 30 December

Source: ICBC company presentation, (Bloomberg, 30 December 2011)

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- 29 - IMD-1-0327 Exhibit 8 ICBC Ranking and Awards Source: ICBC 2011 annual report

- 29 -

IMD-1-0327

Exhibit 8 ICBC Ranking and Awards

- 29 - IMD-1-0327 Exhibit 8 ICBC Ranking and Awards Source: ICBC 2011 annual report This

Source: ICBC 2011 annual report

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- 30 - IMD-1-0327 Exhibit 9 ICBC’s Executive Directors 2012 Jiang Jianqing Chairman of the

- 30 -

IMD-1-0327

Exhibit 9 ICBC’s Executive Directors 2012

Jiang Jianqing

Chairman of the Board of Directors, Executive Director

Mr Jiang has served as Chairman of the Board of Directors and Executive Director of Industrial and Commercial Bank of China Limited since October 2005. He joined ICBC in 1984, and was appointed President in February 2000. Mr Jiang previously served in several positions including Deputy Head of ICBC Shanghai Branch, President of Shanghai Urban Cooperation Commercial Bank (now known as Bank of Shanghai), Head of ICBC Shanghai Branch and Senior Executive Vice President of ICBC. At present, he is concurrently a member of the Monetary Policy Committee of the People’s Bank of China, Vice Chairman of China Society for Finance and Banking, and a tutor to PhD students of Shanghai Jiao Tong University. He graduated from Shanghai University of Finance and Economics and Shanghai Jiao Tong University, and received a Master’s degree in Engineering and a Doctorate degree in Management from Shanghai Jiao Tong University.

Yang Kaisheng

Vice Chairman, Executive Director, President

Mr Yang has served as Vice Chairman, Executive Director and President of Industrial and Commercial Bank of China Limited since October 2005. He joined ICBC in 1985, and served in several positions including Deputy General Manager of ICBC Discipline Enforcement Office, General Manager of ICBC Planning and Information Department, Head of ICBC Shenzhen Branch, Senior Executive Vice President of ICBC, President of China Huarong Asset Management Corporation. He graduated from Wuhan University with a Doctorate degree in Economics.

Wang Lili

Senior Executive Vice President

Ms Wang has served as Senior Executive Vice President of Industrial and Commercial Bank of China Limited since October 2005, and Executive Director since April 2010. She was appointed as Senior Executive Vice President upon joining ICBC in November 2000. She previously served in several positions including General Manager of the Credit Management Department, General Manager of the Risk Management Department, and Assistant to President of Bank of China. She once also served as Chairperson of Bank of China (Canada) and Yien Yieh Commercial Bank Ltd. (Hong Kong), respectively. Currently she is China’s representative of APEC Business Advisory Council, a member of APEC Women Leaders’ Network, a board member of International Swaps and Derivatives Association, Vice Chairperson of China Chamber of International Commerce, Chairperson of the Board of Directors of ICBC (London) Limited, Vice Chairperson of China Society of International Finance, Vice Chairperson of National Debt Association of China, and Vice Chairperson of the Board of Directors of Hong Kong Mercantile Exchange. She graduated from Nankai University and received an MBA degree from University of Birmingham, UK.

Li Xiaopeng

Senior Executive Vice President

Mr Li has served as Senior Executive Vice President of Industrial and Commercial Bank of China Limited since October 2005, and Executive Director since October 2010. He joined ICBC in 1984, and was appointed as Senior Executive Vice President of ICBC in September 2004. He previously served in several positions including Deputy Head of ICBC Henan Branch, General Manager of the Banking Department of the Head Office, Head of ICBC Sichuan Branch, Vice President of China Huarong Asset Management Corporation, and Assistant to President of ICBC and Head of ICBC Beijing Branch. He serves concurrently as Chairman of ICBC Financial Leasing Co., Ltd., Chairman of ICBC Credit Suisse Asset Management Co., Ltd., Vice Chairman of China Urban Financial Society, Vice Chairman of China Institute of Rural Finance, Head of the Financial Leasing Committee and the Development and Research Committee of China Banking Association. He graduated from Zhengzhou University and received a Doctorate degree in Economics from Wuhan University.

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- 31 - IMD-1-0327 Exhibit 9 (continued) Qian Yingyi Independent Non-executive Director Mr Qian has

- 31 -

IMD-1-0327

Exhibit 9 (continued)

Qian Yingyi

Independent Non-executive Director

Mr Qian has served as Independent Non-executive Director of Industrial and Commercial Bank of China Limited since October 2005. He had taught at the Department of Economics at Stanford University, University of Maryland and University of California, Berkeley, and served as Independent Non-executive Director of China Netcom Group Corporation (Hong Kong) Limited. He is Dean of the School of Economics and Management of Tsinghua University, and is concurrently the Chairman of the Board of Supervisors of Vtion Wireless Technology AG. He graduated from Tsinghua University and received a Doctorate degree in Economics from Harvard University.

Xu Shanda

Independent Non-executive Director

Mr Xu has served as Independent Non-executive Director of Industrial and Commercial Bank of China Limited since September 2007. From January 2000 to 2007, he was appointed as Deputy Commissioner of the State Administration of Taxation (SAT). He worked as Deputy Director-General of the Tax System Reformation Department of SAT, Deputy Director-General and Director-General of the Policy and Legislation Department of SAT, Director-General of Local Taxes Department of SAT, and Director- General of Supervisory Bureau of SAT. He is currently member of the National Committee of the Chinese People’s Political Consultative Conference, Chairman of the China Certified Tax Agents Association, consultant to the China Public Finance Society, member of the Chinese Economist 50 Forum and member of the 50 Forum Academic Auditing Committee. He is the Independent Director of China Pacific Insurance (Group) Co., Ltd., part-time professor and invited researcher of Tsinghua University, Peking University, National School of Administration, Xi’an Jiaotong University, University of Science & Technology of China, Nankai University, Central University of Finance and Economics and Zhejiang Engineering University. He received his Bachelor’s degree from Department of Automation, Tsinghua University, Master’s degree in Agricultural Economics & Management from the Chinese Academy of Agricultural Sciences, and Master’s degree in Finance from the University of Bath in UK.

Wong Kwong Shing, Frank

Independent Non-executive Director

Mr Wong has served as Independent Non-executive Director of Industrial and Commercial Bank of China Limited since January 2009. He previously held a number of senior positions with regional responsibility at financial institutions including Citibank, JPMorgan and NatWest, and took positions as Chairman of Hong Kong Futures Exchange Limited, Chairman of the Leveraged Foreign Exchange Trading Ordinance Arbitration Panel and member of the Foreign Exchange and Money Market Practices Committee of Hong Kong Association of Banks. He joined DBS Bank in 1999, and served as Vice Chairman of DBS Bank Ltd., Director and Chief Operating Officer of DBS Bank Ltd. and DBS Group Holdings, and Chairman of DBS Bank (Hong Kong) and Chairman of DBS Bank (China). He also served as the Independent Non- executive Director of the National Healthcare Group Pte Ltd under the Ministry of Health of Singapore. At present, he is concurrently a Director of PSA International Pte Ltd, Mapletree Investments Pte Ltd and China Mobile Limited, and a member of the University Court of The University of Hong Kong.

Malcolm Christopher McCarthy

Independent Non-executive Director

Sir M.C. McCarthy has served as Independent Non-executive Director of Industrial and Commercial Bank of China Limited since December 2009. Sir M.C. McCarthy worked first as an economist for ICI before joining the UK Department of Trade and Industry where he held various posts from economic adviser to undersecretary. He subsequently worked as the senior executive of Barclays Bank first in Japan and then North America. He served as Chairman and Chief Executive of Office of Gas and Electricity Markets (Ofgem), and Chairman of the Financial Services Authority (FSA). Currently Sir M.C. McCarthy serves as a non-executive director of HM Treasury, and also Chairman of the board of directors of J.C. Flowers & Co. UK Ltd, an independent non-executive director of Intercontinental Exchange, a non-executive director of NIBC Holding N.V, NIBC Bank N.V., OneSavings Bank plc and Castle Trust Capital plc, and a Trustee of Said Business School. He is an Honorary Fellow of Merton College, an Honorary Doctorate of the University of Stirling, and a Freeman of the City of London. He has a MA History at Merton College of Oxford University, PhD Economics of Stirling University, and MS Business at Graduate School of Business of Stanford University.

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- 32 - IMD-1-0327 Exhibit 9 (continued) Kenneth Patrick Chung Independent Non-executive Director Mr Chung

- 32 -

IMD-1-0327

Exhibit 9 (continued)

Kenneth Patrick Chung

Independent Non-executive Director

Mr Chung has served as Independent Non-Executive Director of Industrial and Commercial Bank of China Limited since December 2009. Mr Chung joined Deloitte Haskins and Sells London Office in 1980. He became a partner of PricewaterhouseCoopers in 1992, and was a financial service specialist of PricewaterhouseCoopers (Hong Kong and China) since 1996. Previously, he was the human resources partner of PricewaterhouseCoopers (Hong Kong), the responsible partner of the audit department of PricewaterhouseCoopers (Hong Kong and China), the global lead partner of the audit engagement team for Bank of China Limited, the honorary treasurer of The Community Chest of Hong Kong and was a member of the Ethics Committee, Limitation of Professional Liability Committee, Communications Committee, and the Investigation Panel of the Hong Kong Society of Accountants. Mr Chung has also served as the audit partner for the restructurings and initial public offerings of Bank of China Limited, Bank of China (Hong Kong) Limited and Bank of Communications Co. Ltd. Currently, Mr Chung serves as the honorary treasurer of International Social Service Hong Kong Branch. He is a member of the Institute of Chartered Accountants in England and Wales, a member of the Hong Kong Institute of Certified Public Accountants and a member of the Macau Society of Certified Practising Accountants. Mr Chung received a bachelor’s degree in economics from the University of Durham.

OR, Ching Fai

Independent Non-executive Director

Mr Or Ching Fai graduated from The University of Hong Kong with a Bachelor’s degree in Economics and Psychology. Fai is a Justice of the Peace he has served an Independent Non-executive Director of Industrial and Commercial Bank of China Limited since May 2012. Mr Or Ching Fai was the General Manager and a Director of The Hongkong and Shanghai Banking Corporation Limited, the Chairman of HSBC Insurance Limited, the Chief Executive and Vice Chairman of Hang SengBank Limited, the Chairman of Hang Seng Insurance Company Limited and Hang Seng Bank(China) Limited. Mr Or Ching Fai was the Chairman of the Hong Kong Association of Banks, the Vice President and a Council Member of the Hong Kong Institute of Bankers, the Chairman of the Financial Services Advisory Committee and a member of the Services Promotion Programme Committee of the Hong Kong Trade Development Council, a member of the Risk Management Committee of the Hong Kong Exchanges and Clearing Limited, a member of the Aviation Development Advisory Committee, the Chairman of Executive and Campaign Committee of the Community Chest of Hong Kong, a Council Member of The University of Hong Kong, an Adviser of the Employers’ Federation of Hong Kong, a Director of Cathay Pacific Airways Limited, a Director of Hutchison Whampoa Limited.

Huan Huiwu

Non-executive Director

Mr Huan has served as Non-executive Director of Industrial and Commercial Bank of China Limited since February 2009. He joined the Ministry of Finance (MOF) in 1982, and served as Chief of the Cadre Deployment Division of the Department of Human Resources, Chief of the Cadre Deployment Division of the Department of Human Resources and Education, Deputy Director-General of the Department of Human Resources and Education, and Executive Deputy Secretary of the Party Committee (at the rank of Director-General). He graduated from the Party School of the Central Committee of the Communist Party of China as a postgraduate in Economics and Administration.

Wang Xiaoya

Non-executive Director

Ms Wang has served as Non-executive Director of Industrial and Commercial Bank of China Limited since January 2012. She previously taught at Central China Normal University where she served as Assistant Lecturer and Lecturer. She joined the Research Bureau of the People’s Bank of China in 1997 where she served as Deputy Chief of department, Chief of department and Deputy Director and served as Deputy Mayor of Tongliao City in Inner Mongolia Autonomous Region at the same time. Ms Wang graduated from the Graduate School of Chinese Academy of Social Sciences and received a Doctorate degree in Economics. Ms Wang also received a Bachelor of Law degree and a Master of Economics degree from the Political and Education Faculty and Economics Faculty of Central China Normal University. Ms Wang Xiaoya is a researcher and is currently a Member of the Post-Doctoral Academic Committee and a Post-Doctoral Co-mentor at the People’s Bank of China Research Institute of Finance

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- 33 - IMD-1-0327 Exhibit 9 (continued) Ge Rongrong Non-executive Director Ms Ge has served

- 33 -

IMD-1-0327

Exhibit 9 (continued)

Ge Rongrong

Non-executive Director

Ms Ge has served as Non-executive Director of Industrial and Commercial Bank of China Limited since January 2012. She has worked at Huijin since 2005 and has served as Deputy Officer and Officer of the Construction Bank Share Management Division of the Banking Department at Huijin and an Employee Supervisor of Huijin. Ms Ge previously served as Lecturer at the Economics Management College of Beijing University of Industry in 1994, and subsequently served as Assistant Researcher at China Eagle Securities Company and staff member of the Department of Public Offering and Supervision at China Securities Regulatory Commission. Ms Ge graduated from China University of Technology and received a Doctorate degree in Management. Ms Ge also received a Bachelor’s degree in Engineering from Zhejiang University and a Master’s degree in Economics from Beijing Normal University. She is a senior economist.

Li Jun

Non-executive Director

Mr Li has served as Non-executive Director of Industrial and Commercial Bank of China Limited since December 2008. He joined Central Huijin Investment Ltd. in 2008. He previously served as Assistant Representative of Beijing Representative Office of the Bank of Credit and Commerce International, Deputy Representative of BNP Paribas China Representative Office, Consultant of the International Banking Department of Banco Bilbao Vizcaya Argentaria, Deputy General Manager of the Research Centre of China Technology Trust and Investment Company, General Manager of the Research Department of China Sci-Tech Securities, and Professor of the Finance Department of the School of Economics and Management of the University of Science and Technology Beijing. He graduated from University of Madrid in Spain and received a Doctorate degree in Business Management.

Wang Xiaolan

Non-executive Director

Mr Wang has served as Non-executive Director of Industrial and Commercial Bank of China Limited since January 2012. He joined the Department of Industry and Transportation of the Ministry of Finance in 1982. He served as Deputy Chief and Deputy Director-General of the State-owned Assets Administration Commission from 1989. Mr Wang served as Chief, Assistant Commissioner and Deputy Supervision Commissioner of the General Office in the Financial Supervision Commissioner Office of the Ministry of Finance in Beijing from 1997. Mr Wang served as Deputy Supervision Commissioner and Supervision Commissioner (at the rank of Director-General) of the Financial Supervision Commissioner Office of the Ministry of Finance in Chongqing City from 2004. Mr Wang graduated from Central University of Finance and received a Bachelor’s degree in Economics. Mr Wang Xiaolan is a senior economist, a certified public accountant and is qualified to practice as a registered asset appraiser.

Yao Zhongli

Non-executive Director

Mr Yao has served as Non-executive Director of Industrial and Commercial Bank of China Limited since January 2012. He joined the Ministry of Finance in 1991 and served as Deputy Officer and Officer at the Theory Department of China Financial and Economic News of the Ministry of Finance and Deputy Chief Editor (at the rank of Deputy Director-General) and Chief Editor (at the rank of Director-General) of China Financial and Economic News of the Ministry of Finance. He graduated from the Economics Faculty of Peking University and received a Doctorate degree in Economics. Mr Yao also received a Bachelor’s degree in Economics and a Master’s degree in Economics from the Economics Faculty of Sichuan University and the Economics Faculty of Peking University, respectively. Mr Yao Zhongli is a senior editorial specialist.

Source: Company website, August 2012

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- 34 - IMD-1-0327 Exhibit 10 Reforming China’s Banking Sector The Big Four The banking

- 34 -

IMD-1-0327

Exhibit 10 Reforming China’s Banking Sector

The Big Four

The banking reform started in 1978 when China initiated its economic reform. Prior to this, China had only one bank, the People’s Bank of China (PBC), which was combined with the MOF. The PBC’s main function was to allocate funds according to the central planning. In 1978, the PBC was separated from the MOF. It acted as a central bank formulating and implementing monetary policy, and at the same time taking deposits and lending to SOEs.

In 1979, Deng Xiaoping forged ahead with plans for a banking reform, summarized into one phrase “transforming banks into real banks.” From 1979 to 1983, three national specialty banks were re-established: Agricultural Bank of China (ABC), the Bank of China (BOC), and the People’s Construction Bank of China (PCBC). 26 In 1984, the commercial banking function of the PBC was spun off and called the Industrial and Commercial Bank of China – ICBC, the fourth national specialty bank in China. The PBC focused on its role as a central bank and a regulatory agency of China’s banking industry.

In the early stages, the Big Four functioned as extensions of the state. Managers and employees were ranked like government officials with top executives being appointed by the State Council. The state became involved in all banking activities, which led to politically oriented business decisions. Without profit-oriented objectives, the banking sector had a poor performance. Bank managers often attributed poor results to political influence and policy lending.

In 1994, the state began its aggressive banking reforms. Three policy banks 27 were established to take over policy lending from the Big Four. The Big Four became state-owned commercial banks with an exclusive focus on commercial banking. In 1995, the Commercial Banking Law came into effect requiring that commercial banks should operate independently, take their own risks, discipline their managers and be responsible for their losses.

28

Although the Big Four were transformed from national specialty banks into commercial banks by law, they were still owned by the state and the transformation to commercial banks was not complete. They were not independent with regard to business decisions and were often ordered to rescue insolvent SOEs. They could not carry out risk management and internal control effectively, which resulted in the first wave of rescues by the state.

In the 1990s, the average ratio of the Big Four’s NPLs was over 30%. In 1996, the Big Four’s CAR was 4.37%, which dropped to 3.5% one year later. 29 This ratio was far below the 8% rule proposed by Basel II. In 1998, the MOF issued special government bonds worth

26 The predecessor of China Construction Bank (CCB).

27 China Development Bank (CDB), Agricultural Development Bank of China (ADBC), and the Export-Import Bank of China (China Eximbank)

28

29 Li, Liming, 2008, The ownership reform of state-owned commercial banks (In Chinese), Citic, page

29.

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- 35 - IMD-1-0327 RMB 270 billion ($32.7 billion) to inject capital into the Big

- 35 -

IMD-1-0327

RMB 270 billion ($32.7 billion) to inject capital into the Big Four to raise their CAR. In 1999, four asset management companies were established to buy a large portion of NPLs.

Capital injection and stripping off the NPLs strengthened the Big Four’s balance sheets, but did not solve the deep-rooted problems of state influence and ownership. Although the Big Four held 60% market share by assets in 2000, they were financially weak, plagued with inefficiency, low earnings, high levels of NPLs and inadequate capital. Further reform was imperative and WTO entry made the task the more urgent. The state was ready to yield part of the ownership and governance to the market.

Domestic Competitors Catching Up

Listing banks on the stock exchange was not new to China’s leadership. In 1987, China opened up the domestic banking market to induce competition and test Western corporate governance practices. A dozen commercial banks, including Bank of Communications and China Merchant Bank, were established. They were all joint-stock commercial banks (JSBs) with a board of directors. JSBs were partly owned by the government and partly by companies and were profit-oriented banks from their inception.

JSBs became the most dynamic force in China’s banking sector. Without state support, they increased their assets and market share rapidly. According to an OECD report, they accounted for 14% of banking assets at the end of 2003. JSBs had lower levels of NPLs and higher CARs. They were also encouraged to test various ownership and governance structures including going public and partnering with foreign banks. The JSB experiment proved that better corporate governance led to better financial results.

Another group of domestic players were China’s city commercial banks, which were developed from urban credit cooperatives. They were partly owned by local governments and partly by local enterprises. Urban credit cooperatives provided financial services to local private enterprises. In 1995, the state transformed these cooperatives into urban cooperative banks, and three years later changed their names to city commercial banks. With similar corporate governance structure, city commercial banks also experienced rapid growth.

There were other smaller players, such as rural credit cooperatives and postal savings banks, with less than 20% market share in China. However, they were not at the same level as the Big Four and thus could not compete. In any case, domestic players such as JSBs and city commercial banks were catching up at a speed twice the growth rate of the Big Four. Without reform, the Big Four would continue losing market share to these fierce domestic competitors.

Global Banks at the Door

Starting in 1981, foreign banks were allowed to operate in China with restricted activities. When China joined the WTO in 2001, the geographic and customer restrictions on foreign banks was gradually removed and full access was granted after 11 December 2006.

China’s domestic banking industry had every reason to panic. Foreign banks were more competitive in terms of size, expertise, sophistication and financial health. In 2000, the asset value of Citigroup alone was approximately equal to the combined asset value of the Big Four. The Big Four were technically bankrupt, and were unable to compete.

The global players were highly motivated looking for growth in China’s domestic market. WTO entry intensified the domestic and foreign competition further and thus increased the threats for the domestic banking industry. However, this was also a great opportunity to

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- 36 - IMD-1-0327 transform the Big Four through external pressure and accelerate the learning

- 36 -

IMD-1-0327

transform the Big Four through external pressure and accelerate the learning from global counterparts. Resistance to banking reform was tackled and Deng’s vision of “transforming banks into real banks” was realized.

Government in Action

The trajectory of China’s banking sector reform showed that better corporate governance did not come easily. In fact, China’s mounting inequalities made corporate governance reform imperative since it contributes to a stable financial system which in turn is essential for the maintenance of social stability.

The leadership demonstrated the highest level of political commitment necessary to enforce corporate governance and processes. Premier Wen Jiabao identified the critical banking reform as a Must-Win Battle. The leadership realized that:

Only through corporate governance reform can SOCBs compete in the domestic and global financial services marketplace;

Only through shareholder diversification can SOCBs be fully commercialized;

SOCBs’ objectives need to be clarified, the government’s role cannot exceed the function of a shareholder and one director of an SOCB board of directors, even though it is a major shareholder, and the board of directors is the sole authority empowered to direct SOCB management. 30

The government-led transformation was accompanied by legal and ownership reform. An independent banking regulation entity, the China Banking Regulatory Commission (CBRC), was created to enforce the corporate governance framework in the banking sector.

1. Reforming the legal framework to promote fairness, transparency and accountability

Corporate governance deals with the laws and customs governing corporations. A robust legal environment should include a comprehensive set of legislation, transparency in the legislation and administration process, impartial enforcement of the law, and limits on the exercise of state power. A high quality legal system leads to efficient corporate governance and investor protection.

In recent years, e-government initiatives were launched to make the government administration more transparent. China also took steps to build a rule-based legal system, improve legal transparency and reduce the influence of personal connections on business and law enforcement.

In 1999, the concept of the rule of law was amended to the Chinese Constitution. Subsequent laws such as the Administrative Litigation Law, the State Compensation Law, the Legislation Law and the Administrative Licensing Law had significant importance on the checks to limit state power. In 2004, a new amendment to the Constitution adopted explicit

30 Bu,

http://www.afdc.org.cn/upload/16/downloads/Bu %20Yongxiang.pdf.

Yongxiang.

“Government’s

role

in

enhancing

China’s

SOCBs

corporate

governance.”

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 37 - IMD-1-0327 rules to protect private property rights. In May, 2004 the state

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rules to protect private property rights. In May, 2004 the state issued a detailed guideline 31 towards building a rule of law-based society. Although the legal reform had been launched, the country remained in transition, so legal inefficiencies were not uncommon at that stage.

2. Reforming the state ownership

In China, the state was the sole owner of the Big Four, and it was supposed to monitor bank managers. The state largely exercised control through direct intervention including management appointment and removal. Bank managers were not owners and were often demotivated due to limited decision-making power. Realizing the agency problems, the state granted bank managers greater authority over business decisions in order to increase incentives and efficiency. This led to insider control problem as many top bank managers were later found guilty of abusing their power for personal gains. The state did send representatives to monitor managers. However, these representatives lacked information, expertise and incentives to select and monitor bank managers.

The poor governance structure, both insider control issues and agency problems were related to state ownership. To improve the corporate governance in the banking sector, the state had to relinquish part of the ownership to non-state investors in exchange for more efficient monitoring. Non-state investors would bring in management expertise and require bank managers to generate returns and serve the best interests of the shareholders. The market for bank managers would be more competitive. As a result of this change, agency problems such as abuse of power and corruption would decrease and efficiency would likely increase.

The leadership believed that full privatization would take time and that the state should remain active, if not dominant, in a number of sectors including the banking sector. The logic was clear: during the reform period, the state had to respond swiftly to economic, financial or social crises; control of key sectors also facilitated drastic economic reforms. 32 In December 2003, China set up a company called Central Huijin Investment Ltd (Huijin), 33 owned by the state council. The company would act as the shareholder of state assets in the SOCBs. A new regime of corporate governance including board of directors and supervisors would guide the company and select management. Under this new governance structure, the government, as represented by Huijin, should only influence management decisions at SOCBs through voting at the Shareholders’ Meeting and directorial and supervisory board participation as defined in the law. This marked a crucial step in separating ownership, bank management and the regulatory function of the state.

31 The Guideline for Advancing Administration in Accordance with the Laws.

32 In 2003, Li Rongrong, chairman of the State-Owned Assets Supervision and Administration Commission of the State Council (SASAC), said: “Public ownership, as the foundation of the socialist economic system, is a basic force of the state to guide and promote economic and social development and a major guarantee for realizing the fundamental interests and the common prosperity of the majority of the people… The state owned economy has taken a dominant place in major trades that have a close bearing on the country’s economic lifeline and key areas, and has propped-up, guided and brought along the development of the entire socio-economy. The influence and control capacity of SOEs have further increased. State owned economy has played an irreplaceable role in China’s socialist modernization drive.” 33 Huijin was merged into China Investment Corporation (CIC), China’s sovereign wealth fund, when CIC was established in 2007.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 38 - 3. Reforming the regulatory framework IMD-1-0327 Driven by the political commitments to

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3. Reforming the regulatory framework

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Driven by the political commitments to improve corporate governance, China pushed for financial sector reforms with specialized regulators. These regulators developed national legislation aimed at improving corporate governance. Many international and regulatory organizations and high profile companies such as OECD, World Bank, IMF, SEC, and IFC were consulted regarding new regulations.

Created in 1992, the China Securities Regulatory Commission (CSRC) governed securities exchanges and futures markets in China. CSRC issued:

a host of regulations early 2001 that constituted a significant leap toward bringing its

regulatory regime into line with international standards. They included a directive mandating quarterly reporting; guidelines on qualifying and appointing independent directors; rules aimed at enhancing disclosure, improving the workings of the stock market, and codifying inspections of listed companies; a national corporate governance code; and an amended directive on the form and content of quarterly reports. More recently, regulations have strengthened the position of minority shareholders. 34

The IFC was reported to provide comments on various drafts of the new codes by CSRC and PBC to create a regulatory framework for better corporate governance. The IFC also assisted the China Insurance Regulatory Commission (CIRC) to formulate effective insurance policies by financing a benchmark study of regulatory regimes in several developed economies.

In June 2002, PBC issued Guidance on Independent Directors and External Supervisors of Joint-Stock Commercial Banks, which aimed at bringing in independent directors. In 2003, CBRC was established to take over the supervisory functions from PBC. The PBC retained significant regulatory power concerning monetary policies and financial system liquidity to promote economic growth and price stability. CBRC became the banking supervision entity which focused on the financial strength of financial institutions such as implementing capital adequacy ratios. Another objective of CBRC was to restructure the banking sector, especially the Big Four, with efficient decrees and regulations. CBRC and PBC coordinated in many areas of banking regulatory functions.

In the banking sector, CBRC worked with many international organizations. CBRC went further to have an international council of advisors, the first formal body of foreign advisors assembled to offer professional guidance to CBRC. The advisors include some high profile

individuals such as Howard Davies,

Sir Edward George, 36 Andrew Crockett 37 and Gerald

Corrigan. 38 They were heavily involved in the development of legislation relevant to China’s

financial sector. 39 The new legislation included many guidelines and laws, such as the

35

34 IFC, 2005, Step by Step, Corporate Governance Models in China, World Bank publication.

35 Former chairman of the UK Financial Services Authority.

36 Former governor of the Bank of England.

37 Former general manager of the Bank of International Settlements.

38 Former head of the Federal Reserve Bank of New York.

39 Nola, Jane. “The Influence of Western Banks on Corporate Governance in China.” Asia Pacific Business Review, Vol. 16, Iss. 3, 2010: 417-436.

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at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 39 - IMD-1-0327 Guidelines on Due Diligence Performance of the Boards of Directors of

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Guidelines on Due Diligence Performance of the Boards of Directors of Joint Stock Commercial Banks, the Guidelines on Corporate Governance Reforms and Supervision of Bank of China and China Construction Bank, the Anti-Money Laundering Law, the Anti- Monopoly Law, and the Banking Supervision Law.

CBRC made available a legal and regulatory framework demanding the adoption of international operation standards, information disclosure, and protection of shareholders, depositors and other stakeholders of the bank. CBRC clearly encouraged SOCBs to diversify ownership by introducing domestic and foreign strategic investors. The maximum equity share held by a single foreign investor in a Chinese bank was raised from 15% to 20%. Increasing number of foreign banks became shareholders in the Chinese domestic banks, holding board seats, and even becoming part of the executive management team.

Corporate governance eliminated the risk of returning to the NPLs issue, which in the past plagued the country’s banking sector. Liu Mingkang told the Financial Times that the CBRC would impose 10 guidelines to improve governance. “It’s a very challenging job and my house will be responsible for making sure it will be a ‘never-again story’ through corporate governance and transparency.”

4. Creating a unique corporate governance structure

The OECD provides the most authoritative functional definition of corporate governance:

“Corporate governance is the system by which business corporations are directed and controlled. The corporate governance structure specifies the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs. By doing this, it also provides the structure through which the company objectives are set, and the means of attaining those objectives and monitoring performance.”

From this definition, corporations should act consistently with the interests of stakeholder groups, including shareholders. The stakeholder concept was the latest achievement in the developed economies after decades of practices designed to fight corporate scandals and crimes. As China’s economic transformation deepened, building effective corporate governance mechanisms became imperative. A market and stakeholder-oriented governance approach was a ready example.

However, corporate governance is path dependent, good governance has to take into account the identity of the legal and regulatory framework, culture, custom, norms, society and organizational structures. Worldwide governance practices show that there is no “one size fits all” solution. In particular, the political economy of China, a socialist market economy with Chinese characteristics, faced unique challenges so governance reform had to be developed with careful design and enforcement. While governance reform might push for standardization across industries and regions, companies might have been at different levels in adopting the new governance mechanisms.

According to the Company Law, China’s corporate governance model has a four-tier

structure including the shareholder meeting, the board of directors, the board of supervisors

and the senior management team.

The governance structure establishes the respective

40

40 In Chinese, .

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 40 - IMD-1-0327 powers of each of these institutions and provides effective checks and

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powers of each of these institutions and provides effective checks and balances. The

Company Law embraces a very broad stakeholder approach requiring listed companies to act

in the best interests of the companies and the shareholders, and take into account the welfare,

environmental protection, community interest and social responsibility.

Shareholder meetings in China go beyond voting on directors and reviewing annual reports.

A company might have several interim shareholder meetings in a year to decide on key

issues such as major investments and acquisition, changes in operation policies and procedures, share issuance and debt issuance. The shareholder meeting has the ultimate authority in the company.

In the four-tier Chinese system, the board of directors is composed of both non-executive

and executive directors elected by shareholders, similar to that of the UK or US. The non-

executive directors are expected to outnumber executive directors and hold key posts, including audit and compensation committees. The board of directors is accountable to the shareholders and exercises the power of strategic direction, and the hiring and firing of managers.

Under the direction of the board of directors, the senior management team is the execution layer, which is responsible for the daily operation and management activities. The Anglo- American model is market oriented, more transparent, and emphasizes the interests of shareholders. However, recent corporate failures and scandals show that this model has its defects particularly when entrenched management abuses power for personal benefits.

The board of supervisors exercises checks on the management team and the board of directors, and it balances the power of the board of directors. In the four-tier system:

…a board of supervisors shall be composed of representatives of the shareholders and an appropriate proportion of representatives of the staff and workers of the company, namely, not less than one-third of the number of the board of supervisors. 41

While the composition of the board of supervisors is similar to that of Germany, 42 unlike supervisory boards in Germany which make major business decisions, Chinese supervisory boards do not have the same ex ante and ex post strategic decision-making power. Their main function is ex post and in-between controls: examining the financial affairs, supervising the acts of the directors and senior managers, and making sure laws and regulations concerning corporate governance are strictly followed. Established according to the stakeholder approach, a board of supervisors is a means of protecting external investors’ rights and improving corporate governance.

Governance Was a Path That Had No End

As a result of institutional constraints, a complete separation from the old control system would not be easily achieved in the public SOEs. The state needed to push for deeper structural reform to enforce the new governance structure. The practice of fusing the old

41 The Company Law of the People’s Republic of China, October 27, 2005.

42 In the German system, the supervisory board was made up entirely of non-executive directors who represent shareholders and employees. The executive board was made up of company executives who run day-to-day operations.

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

- 41 - IMD-1-0327 system into the new structure, or the illusionary separation between the

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system into the new structure, or the illusionary separation between the board and the party committee would not work. Standardized guidelines were not enough to make governance successful and a culture of governance should impregnate the whole organization. The control mechanism, a board of supervisors and the party disciplinary commission, would not function if not properly implemented.

Many public companies lacked the party committees to exercise control as they were once privately owned. For these companies, the board of supervisors was at risk of becoming a window dressing device. Moreover, non-executives directors were not independent, and thus provided no checks and balances on executive directors or top management. As a result, transparency, information disclosure, management credibility and regulatory compliance were not complete or sufficient. Because of the lack of effective monitoring, managers, controlling shareholders and directors, pursued their own interests at the expense of minority shareholders. Insider control often led to the following practices:

Transferring and misappropriating companies’ assets through unfair related party transactions

Engaging in self-dealing for personal gains

Presenting false accounting records to the regulatory body and investors, and using inside information for personal gains

Developing personal connections by using company resources. 43

China needed to improve its regulatory practices, such as insufficient law and governance enforcement. The initiative to provide training and education to directors was a major step to improving corporate accountability and performance. Mr Wong highlighted an additional dimension of governance evolution in China:

For China in general, there are so many regulations, and some of them were written into law. Corporate governance standards are rule-based, as opposed to principle-based. Overseas they are often principle-based, which encourages more lateral thinking in interpreting these rules. In China they are more rule-based, which sometimes inhibits lateral thinking and creativity. Depending on how soon or how fast the economy changes, governance will be likely to become more market-based.

Governance is a continuous process and full transparency and effective corporate governance take time to accomplish.

Corporate

http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan033858.pdf.

43

Shi,

Chenxia,

International

Governance

Developments:

The

Path

for

China,

This document is authorized for use only in Prof. Pankaj Kumar Baag's Strategic Leadership Programme

at Indian Institute of Management - Kozhikode from Sep 2018 to Mar 2019.

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