Friday, July 10, 2009

State Owned Enterprises and the Integrity of Private Markets and Commercial Activity: On the Arrest of the Rio Tinto Executive

Over the last decade states have aggressively projection of state power into private markets. But they have also evidenced a desire to preserve the legal and political divisions between their role as sovereigns and as actors in private markets. The object, of course, is to preserve a monopoly of political power in states while allowing the leaking of this state power within the private markets in which individuals and juridical persons (corporations and other aggregate entities) might assert power. This has been most apparent in recent moves to create a soft regulatory environment for the outbound investment activities of sovereign wealth funds. See Larry Catá Backer, Sovereign Wealth Funds as Regulatory Chameleons: The Norwegian Sovereign Wealth Funds and Public Global Governance Through Private Global Investment, Georgetown Journal of International Law, Vol. 41, No. 2, 2009. Available at SSRN:

But the ability, or even the willingness, of states to preserve this division between public and private power has proven to be hard to maintain. This is especially the case, it seems, when a melding of the private and sovereign roles of the state suit its particular purposes. Consider the following as a harbinger of things to come:
China confirmed Thursday that it had detained an Australian executive and three Chinese employees of the Anglo-Australian mining giant Rio Tinto on suspicion of spying on China, stealing state secrets and causing the country “enormous economic losses.” The executive, Stern Hu, is believed to be one of the highest ranking Western executives ever accused of spying on China. “The Chinese government has gained strong evidence to prove they were spying and stealing China’s state secrets,” Qin Gang, a spokesman for the foreign ministry, said at a press briefing in Beijing on Thursday. David Barboza, China Said to Arrest Rio Tinto Executive, The New York Times, July 10, 2009.
What makes the case interesting is the conflation of a state and market activities. When the state is participant in private market activities, actions that might be considered good or bad business practice can be transformed from economic to political criminality. The stakes become much higher for private market participants, but only in their interactions with states as private actors in markets.
The case sent shock waves through the global mining industry, and Australian politicians suggested the detentions were retaliatory. Rio Tinto scrapped plans last month to accept a $19.5 billion investment from Chinalco, a Chinese state-owned company. Rio Tinto chose instead to raise money from existing shareholders and form a joint venture with another Anglo-Australian company, BHP Billiton. Barboza, supra.
When the character of commercial activity, even wrongly activity, changes character from an economic to a political crime, the distinction between private and public spheres is more likely to collapses. Thus, "Rio Tinto made no comment Thursday, but a day earlier, it issued a statement saying the company did not believe any of its employees in China had engaged in espionage." And that may be true enough--the actions were not directed against the state, as sovereign. But it does appear that the activity was intended to advantage Rio Tinto in its dealings with competitor enterprises in markets that touched on Chinese state economic policies affecting enterprises controlled by the state. That had the effect of transforming competitive market activity into anti state activities. That is certainly how the Chinese officially saw it.
Qin confirmed that four employees from Australian firm Rio Tinto Group’s Shanghai office, including Stern Hu, general manager of the office, were detained on the evening of July 5 by China’s state security department, on suspicion of espionage and stealing national state secrets for other countries. Qin said that the suspects were arrested once relevant departments had obtained conclusive evidence proving that they had been working as spies and had stolen national state secrets, severely damaging China’s economic interests and security. Rio Tinto Spy Case Should Not Affect China-Australia Relations, People's Daily Online, July 10, 2009.
And indeed, from the Chinese perspective, the issues were state to state rather than market commerce oriented.
"Qin pointed out that this is just one individual judicial case that should not affect overall China-Australia economic and trade cooperation, adding that China-Australia economic and trade cooperation is win-win. China will continue to positively support China-Australia economic and trade cooperation, including cooperation between enterprises of the two countries, because these activities are not only beneficial to China, but also to Australia. Relevant parties should not exaggerate or politicize the case." Rio Tinto Spy Case Should Not Affect China-Australia Relations, supra.

Yet that transformation might well produce collateral effects--from a suspicion of the integrity of markets, to the inability of the Chinese state apparatus to convince others that its enterprises are not public interventions in otherwise private markets. Moreover, the privileging of this political transformation also hides the commercial issues underlying the events--recent attempts to purchase a large stake in Rio Tinto by Chinalco, a Chinese State Owned Enterprise, had been resisted. And on the eve of the arrest, Chinalco was again attempting to increase its stake in Rio Tinto.
Aluminum Corporation of China (Chinalco) confirmed Thursday it had bought 1.5 billion U.S. dollars of Rio Tinto shares to cement its 9 percent shareholding in the miner. The deal was made to maximize the interests of Chinalco, Lu Youqing, Chinalco's vice president, told Xinhua. If Chinalco did not made the deal, its shareholding in the miner would decrease from 9.3 percent to about 6 percent. The deal came after Chinalco's 19.5 billion U.S. dollars bid failed last month to raise its stake in Rio Tinto. Chinalco confirms buying $1.5 bln of Rio Tinto shares, People's Daily Online, July 2, 2009.
"Chinalco was established in 2001 when 12 Chinese enterprises and institutions in the aluminum industry were consolidated into Chinalco." Chinalco, History. And indeed, "Chinalco maintains an ongoing global expansion strategy and has made significant steps towards its goal of being a leading globally diversified mining company. . . . Aluminum Corporation of China Limited (“Chalco”), a subsidiary of Chinalco (38.56% owned), is listed in New York, Hong Kong and Shanghai and has a BBB+ credit rating from Standard & Poor’s. Chinalco also indirectly owns 26.61% of Yunnan Copper Co. Ltd, a Shenzhen-listed company." Chinalco, Key Facts and Numbers.

The implications are difficult to avoid. The suspicion of the use of state power, and the politization of maneuverings among commercial enterprises can only raise the suspicion that private market activity is "rigged." Or, perhaps worse, that states will use their sovereign power to aid their state owned or privileged enterprises in their commercial dealings with other private enterprises. In the context of the Rio Tinto episode, this has been a long time coming.
Within China, there is plenty of speculation that Beijing had a hand in the Chinalco-Rio deal, which has cast uncertainty over Anglo-Australian resources giant BHP Billiton's plan to complete a hostile takeover of Rio Tinto for $100 billion. BHP must make a formal offer by Feb. 6 or withdraw its bid for at least six months (, 2/1/08). The assumption among some observers is that China is raising a warning flag to alert BHP that any move to take over Rio will not go unchallenged. "From what we understand, [Chinalco] is representing the Chinese government in this deal," says Ren Baifeng, an analyst with Antaike, a market research firm focused on the metals industry. "Two Fridays ago, there was word that Rio Tinto's management was secretly in Beijing for talks about this deal," he adds. Dexter Roberts and Chi-Chu Tschang,Why Chinalco's Buying Into Rio Tinto: The Chinese giant's new stake in the mining outfit is seen as Beijing's attempt to head off a BHP Billiton takeover, to protect the mainland's supply of ores, Business Week, February 5, 2008.
But that sort of conflation of public and private activity--projection of political power abroad indirectly through private state owned enterprises to mask (and not all that well) for the purposes of executing political goals also tends to affect perceptions of the integrity of markets. And it can produce reciprocal action, all to the detriment of the private in economic activity. This has been the great fear of sovereign wealth fund activity. But it seems that the greater danger might well come form the investment activities of state owned enterprises acting as surrogates for the state. For some, especially those who believe that all economic activity is essentially political, and that political activity ought to be exercised by ort through the state, this is a positive development in the destruction of the global system of private and private activity privileging markets. Yet, it appears to contradict the collective policies that have produced the ground rules of economic globalization. Perhaps it also signals the need to extend enterprises like those that produced the Santiago Principles for sovereign wealth fund behavior, as flaws as I have suggested they might be (See Larry Catá Backer, Sovereign Wealth Funds as Regulatory Chameleons: supra), to state owned enterprises as well. And the OECD Guidelines on Corporate Governance of State-Owned Enterprises might also serve that purpose (more on this in a later post). But the arrest of the Rio Tinto executive suggests the difficulty of maintaining the wall of separation between state sovereign and participatory activity especially in the conduct of the activities of its state owned enterprises.

And what applies to China today might well apply to that nearly constituted giant American state owned enterprise--General Motors. "The new General Motors Co. was born this morning in the offices of a bankruptcy lawyer in New York, a quiet moment after a year of turmoil for the nation's largest automaker, as GM's CEO vowed that "business as usual is over." . . . The documents creating the sale of most of the old GM's assets to a new company owned chiefly by the U.S. government were executed about 6:30 a.m." Justin Hyde and Tim Higgins, Henderson: 'Business as Usual' Over is at GM, Detroit Free Press, July 10, 2009. The irony and double meaning is likely lost on most. And indeed, the hand of its new owners were already very much in evidence in discussions about the labor relaitons issues tied to the GM restructuring. "Steve Rattner, the head of the Obama administration's autos task force, said earlier this week that it would be "natural" for Henderson to cut layers of management to make the company "a bit closer to the ground, leaner and meaner."" Kevin Kroliki, With good assets sold, "New GM" exits bankruptcy, News Daily, July 10, 2009.

States have been at some pains to construct for the assurance of each other (as they project economic power into each others' territories) and for the assurance of private economic actors (as they seek to distinguish between regulatory actions meant to protect the integrity of markets from participatory actions meant to protect their investments like other private actors). See Larry Catá Backer, The Private Law of Public Law: Public Authorities as Shareholders, Golden Shares, Sovereign Wealth Funds, and the Public Law Element in Private Choice of Law, Tulane Law Review, Vol. 82(1):1801-1868, 2008. . Now that distinction between states as sovereigns and states as participants has been exposed as less an accomplishment (or even a desire among states) than as a potentially empty assurance, especially in the hard cases.

With the rise of great sovereign industrial giants under the framework rules of economic globalization, including the United States and China, the haphazard amalgamation of sovereign and market power, when directed to the benefit of sovereigns as market participants, bodes ill for the preservation of market integrity and the maintenance of level playing fields in the economic sphere. States, it seems, may as easily regulate and control private markets indirectly, by displacing private actors in private markets, as by direct regulation, even as they regulate those markets directly in the traditional manner (through law and other expressions of public power). But when sovereigns use sovereign power for the economic advantage of their forays into markets under the guise of acting like other private participants in markets, which they might not directly regulate, while using sovereign authority to regulate those portions of markets under their political control, then the notion of the private in markets may lose all current meaning. What emerges remains to be seen. But for a hint of one possibility of the direction of drift, see, Larry Catá Backer and Augusto Molina, Cuba and the Construction of Alternative Global Trade Systems: ALBA and Free Trade in the Americas, University of Pennsylvania Journal of International Economic Law, Vol. 31, No. 3, 2010 (forthcoming).

1 comment:

Anonymous said...

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