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Put a little Hong Kong whitewash on your Rusal brush, and look at the difference it makes to your teeth…

Before After

By John Helmer in Moscow

A left turn and quick walk out of the Hong Kong Stock Exchange (HKEx) building on the waterfront in Central Hong Kong will take you to the ferry for Macau, where, in less than sixty minutes , you can be at the roulette wheel of the Sands Macau; and within a comparable interval you can gamble away a fortune. This Thursday, inside a closed meeting-room of the exchange, a handful of insiders will decide whether the HKEx intends to spin a wheel of its own, and offer a betting opportunity to a selected group of financial institutions. The HKEx wager is much bigger; the odds less chancy.

This is something the HKEx has never done before – vote on whether to allow the first application ever lodged by a Russian company to sell shares in the Hong Kong market. The company, United Company Rusal, failed in previous bids to list in London in 2007, and in Hong Kong and Shanghai in 2008. Then the underwriters and share-buyers were uncomfortable with Rusal’s risks.

Now, with a market valuation target of between $20 billion and $30 billion, and a 10% issue of shares to be offered, between $2 billion and $3 billion in cash is at stake — all of it promised, according to sources close to Rusal, to the very banks and underwriters, accountants and lawfirms, which have drafted the Rusal share prospectus and the HKEx application, and are participating in the share sale. But now, compared to 2007 and 2008, Rusal is in different shape, with revenues dwindling as the aluminium price is down; huge asset writedowns and bottom-line losses; the biggest debts of any company in Russia; its Russian assets now held for security by Russia’s state banks; and litigation pending in the UK and Guinea to reclaim shares and assets on grounds of contract violation, fraud, and tax evasion.

Most significantly, the international banks underwriting the share sale are also owed very large sums of the $8 billion Rusal has been negotiating to repay them for a year now. The latest deadline for Rusal to avoid default and finalize terms expired last weekend, with a fresh extension of time under way.

HKEx is thus at the centre of a grand conversion, potentially, of what until now has been toxic Rusal debt, owed to more than 70 international banks, into cash up front; and into new Rusal equity, for the purchase of which the creditor banks may be lending equivalent sums as are already owed. This massive exercise in shifting value from the liability to the asset column, and cleaning balance-sheets, is probably legal. Transparent is what it is not. That creates a number of risks and legal liabilities, which the exchange executives are reluctant to own up to.

Paul Chow is the outgoing chief executive of the exchange; he will leave office within eight weeks. Mark Dickens heads the listing division, which is directly responsible for assessing Rusal’s application. Following leaks from Rusal that it intended to apply to the HKEx in September, Chow and Dickens said the confidentiality of the application process precluded them from answering questions.

They would not comment on a liability warning issued by the London law firm Dechert, representing Michael Cherney, who is in the UK High Court with a claim against Rusal’s controlling shareholder, Oleg Deripaska, for 13% of Rusal’s shares, or about $4 billion in compensation, based on contracts and a trust Deripaska had signed in Cherney’s favour in 2001. Lawyers in London say that because the UK High Court Justice Christopher Clarke has ruled that Cherney’s claim has “a reasonable prospect of success” — a ruling recently endorsed by the UK Court of Appeal, with trial likely in the spring — a substantial stake in the company must be reserved, and cannot be sold or diluted, until the trial is concluded. If Rusal is allowed to make its initial public offering, a Hong Kong securities lawyer says, then this is likely to take the form of an issue of new shares, which may dilute the value of the existing stakes. He said he expects the banks preparing the Rusal prospectus will disclose the Cherney claim, and the risk that new share buyers will run that Deripaska and the company will have to pay out on the High Court’s order. According to one London securities lawyer, “the Hong Kong Exchange is no better position to violate the law on fraud than the London Stock Exchange.”

Chow’s and Dickens’ spokesman, Scott Sapp, responds by saying the confidentiality provisions of the exchange charter and of the Securities and Futures Ordinance — the Hong Kong statute regulating the market — impose “a strict policy not to confirm or deny whether a company has applied to list on the Stock Exchange, or the progress of any application.” However, Sapp admits that if and when an application for a listing is approved, and before the shares start to sell on the exchange, “all new applicants proposing to list by way of a public offer need to post a web proof information pack (WPIP) on the HKEx website (www.hkex.com.hk) after receiving the Listing Committee’s approval of their listing application. The WPIP is the first opportunity the public will get to know about a potential public offer of a company.” For the time being, there is no approval, so there is no record for Rusal on the exchange’s data link: http://www.hkexnews.hk/reports/prelist/wpip_co_list.htm

The big step is the next one, and that’s what happens this week. The minimum quorum for the Listing Committee to meet is 5, but this time there will be at least 8 seats occupied behind the closed door. Because of the international ramifications of Rusal’s move, there has never before been such public scrutiny of who will occupy those seats.

According to Chow’s spokesman, “all listing applications have to be approved by the Listing Committee in a hearing meeting convened for that purpose; and Listing Committee meetings on listing applications are not public hearings. The meetings are conducted by a committee comprising members from different sectors including at least eight individuals who the Listing Nominating Committee (LNC) considers will represent the interests of investors. Other members include individuals who the LNC considers will be a suitable balance of representatives of listed issuers and market practitioners, including lawyers, accountants, corporate finance advisers and securities brokers.”

Chow and Dickens refuse to give the names of the eight due to convene on November 19. The HKEx’s website gives a list of 28 committee members in all. Seven of them are of special interest, because they work for institutions with a vested interest in Rusal’s debts, company value, and marketable share price. John Moore, a deputy chairman of the Listing Committee, is a lawyer who used to be with Goldman Sachs, and is now with the London-based firm, Herbert Smith. Both are directly connected to Rusal. Herbert Smith acted for Rusal in a recent fee-record High Court case in London, where Rusal was accused of fraud and corruption in the takeover of an aluminium smelter in Tajikistan.

Six others on the Listing Committee have corporate interests linked with Rusal. Jack Chow is a senior executive with the global accountancy, KPMG. That firm, a Rusal source reveals, has prepared the audited financial details in the share prospectus in Hong Kong. Terence Keyes, another Listing Committee member, is with Morgan Stanley, one of the financial backers of Rusal in the past. Anthony Leung, a Committee member, comes from Ernst & Young, another of Rusal’s auditors. Joseph Longo is from Deutsche Bank, one of Rusal’s financial advisors in previous listing attempts, and a major creditor. Daniel Ng is with Fortis Investments and BNP Paribas – BNP is the lead underwriter, with Credit Suisse, of the HKEx bid, and one of the banks that is most vulnerable to Rusal, it if defaults on its debts. Alexander Schrantz is with Goldman Sachs, which has been advisor to Rusal and has assisted in preparing the HKEx listing, until it reportedly withdrew from the underwriting a few days ago.

The HKEx has verified the names of the committee members. In addition, according to the exchange, there is an explicit bar which “preclude[s] a member with a material conflict of interest from participating in the deliberation of the issue or counting as part of the quorum present at the meeting”. Section 16 of the committee’s operational code looks clear and tough: “a member who is in any way, whether directly or indirectly, materially interested in a matter to be discussed at a meeting must declare any such material interest to the Secretary prior to the meeting or to those present at the meeting and, whenever appropriate and practicable, return all relevant papers to the Secretary as soon as he becomes aware of the conflict. If the member attends the meeting at which the matter is to be considered he must leave the meeting immediately when such matter comes up for discussion.”

Each of the seven with apparent corporate involvement in the business of Rusal was telephoned at his Hong Kong office, and then sent an email to follow up. Each was asked to say if “you planning to attend the scheduled meeting of the Listing Committee next week? Do you intend to recuse yourself from consideration of the listing application of US Rusal on the ground of the potential for conflict of interest, which arises as a result of the business relationship between your company and Rusal?”

Deputy chairman Moore (Herbert Smith) did not answer, along with three others – Chow (KPMG), Ng (BNP), and Schrantz (Goldman Sachs). But here is how Leung (Ernst & Young), Longo (Deutsche Bank), and Keyes (Morgan Stanley) replied:

—– Original Message —–
From: Anthony.Leung@hk.ey.com
Sent: Friday, November 13, 2009 5:41 PM
Subject: Re: From Moscow
Dear Mr Helmer
Thank you for your email. As a member of the Listing Committee, I am subject to statutory obligations to preserve confidentiality under Section 378 of the Securities and Futures Ordinance of the Laws of Hong Kong. I am, therefore, unable to provide answers to the questions you raised in your email.
Kind regards

—– Original Message —–
From: Joe Longo
Sent: Friday, November 13, 2009 12:02 PM
Subject: Re: From Moscow
Thank you for your email. As a member of the Listing Committee, I am subject to statutory obligations to preserve confidentiality under Section 378 of the Securities and Futures Ordinance of the Laws of Hong Kong. I am, therefore, unable to provide answers to the questions you raised in your email.
Joe Longo
General Counsel, Asia (ex-Japan)
Deutsche Bank AG
Hong Kong Branch

—– Original Message —–
From: Keyes, Terence
Sent: Friday, November 13, 2009 11:59 AM
Subject: RE: Please forward to Mr Keyes
Dear Mr. Helmer,
Thank you for your e-mail.
As a member of the Listing Committee, I am subject to statutory obligations to preserve confidentiality under Section 378 of the Securities and Futures Ordinance of the Laws of Hong Kong. I am, therefore, unable to provide answers to the questions you raised in your e-mail.
Terence Keyes
Terence Keyes, Managing Director
Morgan Stanley | Investment Banking Division

The three responses are identically worded. The three Listing Committee members could have expressed their compliance with the conflict of interest code in general terms without violating Sect 378. They might even have cited Sect 379, which requires them to avoid conflicts of interest while discharging their functions on the Listing Committee. But they didn’t.

So they were asked to explain how it happened that they chose exactly the same reply; and whether this had been decided in advance with Chow, Dickens or others in the HKEx. They did not reply.

Chow and Dickens said through their spokesman that “the need to maintain confidentiality, for reasons related to natural justice or due to statutory secrecy provisions applying, means that it is often difficult or inappropriate for the Committee to comment on individual cases.” The conflict of interest in the Rusal case, they imply, is secondary to the confidentiality now covering the Rusal’s listing application.

But that isn’t how Sect 378 of the Ordinance is worded: http://www.legislation.gov.hk/blis_ind.nsf/CurAllEngDoc/792AB069F5C80C304825725F00333C68?OpenDocument
This limits secrecy “to any matter coming to his knowledge by virtue of his appointment under any of the relevant provisions, or in the performance of any function under or in carrying into effect any of the relevant provisions”. But the very next section in the Ordinance, Sect 379, is one of these “relevant provisions”. It makes crystal clear that avoidance of conflicts of interest takes precedence over confidentiality; the latter cannot be used to hide the former.

According to this part of the Hong Kong regulations, “any person performing any function under any of the relevant provisions shall not directly or indirectly effect or cause to be effected, on his own account or for the benefit of any other person, a transaction regarding any securities, futures contract, leveraged foreign exchange contract, or an interest in any securities, futures contract, leveraged foreign exchange contract or collective investment scheme- (a) which transaction he knows is or is connected with a transaction or a person that is the subject of any investigation or proceedings by the Commission under any of the relevant provisions or the subject of other proceedings under any provision of this Ordinance; or (b) which transaction he knows is otherwise being considered by the Commission.”

The HKEx leaders also claim that if the Listing Committee votes approval, new issuers like Rusal will be “required to submit their prospectuses for posting on the HKEx website (www.hkexnews.hk) before listing.” A private company, owned by Deripaska (53%), Mikhail Prokhorov (20%), Victor Vekselberg and Len Blavatnik (18%), and Glencore (9%), Rusal has never issued an audited financial report nor a public investor prospectus document before. If the HKEx gives the go-ahead, it ought to be found at: http://www.hkexnews.hk/listedco/listconews/advancedsearch/search_active_main.as

There is no telling, however, who on the HKEx Listing Committee will have voted to approve the claims the prospectus makes. What the HKEx chairman intends to keep secret for the time being is whether, after the doors close on Thursday’s meeting, those who stand to gain first and most from the share sale, are on the committee voting. If their fingers are on this particular wheel, the outcome of the wager on Rusal shares is no chance at all.

Sources at Credit Suisse and BNP, another of the underwriters in Hong Kong, have been helpful in clarifying aspects of Rusal’s financial condition so long as they are not identified. In the past, Rusal has launched witchhunts into leaks of financial details, threatening banks which disclose information from Rusal presentations with exclusion from lending syndicates. Today there aren’t so many banks which want to accept Rusal performance or repayment risk, and so the deterrent threat has lost some of its sting.

In presentations which Rusal has already made to analysts of the banks interested in the Hong Kong listing, and a parallel one being organized in Paris, revisions have been made to revenue, earnings, and profit results which were handed out during the London Stock Exchange listing attempt in 2007. Many of these are minor, though it is now clear in retrospect that when Rusal told London analysts in June of 2007 that they expected to generate $14.3 billion in sales revenues for their bauxite, alumina, and aluminium, they were exaggerating. The new figure for 2007, as reported in Hong Kong and Paris, is $700 million less at $13.6 billion. Bottom-line net profit figures have been displayed this time round. They range from just over $800 million in 2001 and 2002, to a peak of $2.9 billion in 2006. In 2007, Rusal reports a retreat of profit to $2.8 billion.

Then in 2008, the deluge of red ink began. For last year, the loss came in at $5.98 billion. For the first half of 2009, the loss was $720 million. Although the promoters of the HKEx share sale are playing down the magnitude of these losses, claiming the bulk reflects the writedown of asset values, the collapse of global demand for aluminium, and of the aluminium price, have been a major cause of lossmaking as well. Since Rusal has not been making full payment on its debts, and is seeking to postpone them into the distant future, these costs are omitted from the presentations and reports. The balance-sheet results that have leaked are, as a result, a positive distortion of the company’s current condition.

Still, even that much disclosure has proved too much for the company’s management. According to Vedomosti and the Moscow Times – daily newspapers in Moscow, published in Russian and English, by a syndicate of the Financial Times, Wall Street Journal, and a Finnish media group — “as deeply indebted United Company RusAl sweet-talks foreign investors ahead of a planned initial public offering, it has launched a ‘terror’ campaign at home against a business newspaper. Vedomosti said RusAl and its lawyers were bombarding its journalists with threatening cell phone calls and e-mails after it published a front-page article on Oct. 26 that contained information from a closed-door investors meeting where RusAl announced its 2008 results.”

Sources at Bloomberg say they too have been singled out by Rusal’s chief spokesman, Vera Kurochkina, for similar treatment. Kurochkina has waged a similar campaign against John Helmer’s publishers for many years. She has refused to respond to all email and telephone questions related to Rusal’s business, and threatened to fire any Rusal executive discovered to be communicating with Helmer. Shipping companies carrying Rusal aluminium to North America, and London banks lending Rusal money have been similarly threatened.

Against the Russian media, the threat is to take legal action in the Russian courts for purported disclosure of commercial secrets. Russian law on protection of the press is unclear on what constitutes a commercial secret, if a company like Rusal is advertising versions of its financial reports to dozens of investment institutions worldwide, and making claims to more than seventy of its creditor banks. Not all of them have been covered by nondisclosure agreements and disclaimers; and even those which are cannot be prosecuted if public release and analysis are requirements for transparent market trading of the company’s obligations and shares.

Rusal declares on its website that “by working with international institutions such as the European Bank for Reconstruction and Development and the International Finance Corporation, UC RUSAL developed and implemented its corporate governance standards, based on the principles of transparent and responsible business operations.”

The Securities & Futures Ordinance of Hong Kong requires the offer and sale of shares in Hong Kong to be governed by “such steps as it considers appropriate to maintain and promote the fairness, efficiency, competitiveness, transparency, and orderliness of the securities and futures industry”.

When the Listing Committee members file into their Thursday meeting this week, they will be pushing the envelope in a direction they haven’t been expecting – Hong Kong’s reputation as an international share market.

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