Fed Sets Limits on ICBC Loans to China Fund-Owned Companies

By Scott Lanman

Sept. 4 (Bloomberg) — The Federal Reserve told China’s sovereign wealth fund it cannot subsidize loans for its companies through the New York branch being opened by government-controlled Industrial & Commercial Bank of China Ltd.

Companies controlled by China Investment Corp. may borrow only on “market terms” from the branch of government-owned ICBC, according to a letter released today by the Fed in Washington and dated Aug. 5. Transactions with such companies are limited to 20 percent of the branch’s lending base, the Fed said.

“It’s a reasonable accommodation,” said Gilbert Schwartz, a former Fed associate general counsel who’s now a partner at Schwartz & Ballen LLP in Washington. The central bank has concerns about competition, and the Fed “has an interest in making certain that the branch is maintained on a safe and sound basis,” he said.

The order comes amid increased scrutiny of sovereign wealth funds, the investment companies owned by governments that hold about $2.5 trillion, in Europe and North America. The Group of Seven major nations has called on the funds to ensure their investments are economically, rather than politically, motivated, and urged greater disclosure about their holdings.

An ICBC spokesman didn’t immediately respond to an e-mailed request for comment.

Schwartz said the condition placed on ICBC resembles a provision of the Federal Reserve Act that limits total transactions between a bank and its affiliates to 20 percent of the bank’s “capital stock and surplus.”

Biggest Bank

The Fed granted the $200 billion Chinese fund an exemption from regulation as a bank, according to the separate order approving the ICBC branch, released last month. Beijing-based ICBC, with $1.4 trillion of assets, became the world’s most profitable bank this year and is the biggest by market value. The Chinese government owns about 75 percent of ICBC’s shares.

The conditions are “designed to minimize the potential for conflicts of interests, concentration of resources and unsound banking practices, as well as to mitigate any potential competitive advantage” that CIC may have, the Fed said in the letter released today.

The letter was sent to H. Rodgin Cohen, chairman of New York-based law firm Sullivan & Cromwell LLP, from Robert deV. Frierson, the Fed board’s deputy secretary.

The Fed said CIC-controlled U.S. bank branches “may not cross-market goods and services” in the U.S. with other companies controlled by CIC. The sovereign fund “must continue to conduct a majority of its business outside the United States,” the Fed said.

Acquisition Condition

Also, CIC can’t gain control of a securities firm or insurance company without being subject to regulation as a financial holding company, the Fed said.

An application by China Construction Bank Corp., the country’s second-largest bank, to open a New York branch is pending.

China Banking Regulatory Commission Chairman Liu Mingkang discussed the ICBC application for a New York branch in June talks with Fed Chairman Ben S. Bernanke, part of two days of discussions in Maryland led by Treasury Secretary Henry Paulson and Chinese Vice Premier Wang Qishan.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net

Last Updated: September 4, 2008 13:24 EDT