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Anthony Root spent much of this year working in a room without windows — and, after 6 p.m., without air-conditioning — in a dim Beijing office tower that locals call “the black turd.” Hardly the typical digs of a partner at Milbank, Tweed, Hadley & McCloy, but then this was no ordinary client. Root, based in Hong Kong, is the lead corporate counsel to the China Construction Bank, which used to be part of the Communist Finance Ministry. While CCB is still unpolished by the standards of American boardrooms, its financial heft commands attention. Like the Bank of America Corp., CCB is the third-biggest player in its home market as measured by assets. The Chinese bank’s half-trillion dollars in assets is about two-thirds that of the American bank’s. And, with 14,250 branches, CCB has triple the number of outlets. Not a bad client for Milbank — and not a bad match for Bank of America. With Root’s help, China Construction Bank agreed in June to accept a $3 billion investment from Bank of America. And at press time CCB was poised to complete an initial public offering of more than $7 billion — China’s largest ever. Over the past four months, news has broken of more than $12 billion in other investments linked to the IPOs of China’s state banks. An alliance led by Royal Bank of Scotland Group plc promised to pour $3 billion into Bank of China. A group led by The Goldman Sachs Group Inc. reportedly agreed to pump $3 billion into top-ranked Industrial and Commercial Bank of China. And Temasek Holdings Pte Ltd., a Singapore state company represented by Clifford Chance, unveiled plans to inject $6 billion into CCB and Bank of China. Any one of these deals would set a new record for inbound Chinese investment. The current deal wave represents an advanced stage in China’s twin processes of privatization and market liberalization. The inflow of investment into Chinese banks coincides with their IPOs, which began this summer and will stretch into 2007 and beyond. Since 1997, China has privatized its telecom, airline, insurance, energy, infrastructure and mining sectors. Public listings have smoothed China’s growth by providing the occasion for modernization. Capital markets lawyers are retooling an economy that Goldman Sachs analysts predict will surpass the United States’ by 2041, and their firms are going along for the ride. Sullivan & Cromwell brought China Telecommunications Corporation public. Shearman & Sterling midwifed PetroChina Co. Limited, and Skadden, Arps, Slate, Meagher & Flom privatized China’s second oil giant, Sinopec Corp. Each of these companies is already a global player, with tens of billions of dollars in revenues, and legal needs aplenty. Banks were saved for last, says Shearman’s Matthew Bersani, because their reform is tougher than industrial cleanup. But financial reform is essential if China’s miracle is to be sustained. “The bank IPOs are transformative,” says Bersani, the underwriters’ adviser for Bank of China and Bank of Communications Ltd. “There’s nothing more basic to a society than fixing its financial foundations.” At a more mundane level, no client has greater legal needs than a bank. “We view this as an historic opportunity to become long-term counsel for one, two, three of the biggest Chinese banks,” says Randall Guynn of Davis Polk & Wardwell in New York. Together the trio of ICBC, Bank of China and CCB has assets of $1.66 trillion — more than Citigroup Inc. These enormous new clients are apt to generate follow-on securities offerings, to attract follow-on investments, and to form joint ventures in credit card and wealth management. They’ll need help with structured finance, overseas expansion, and regulatory compliance. And, sooner or later, they’ll need litigators. A handful of firms are especially well-positioned to benefit. Davis Polk’s Guynn gives corporate counsel to ICBC. His Hong Kong colleague, William Barron, is the U.S. capital markets adviser to both ICBC and to CCB’s underwriters. Sullivan & Cromwell’s Chun Wei, who splits her time between Beijing and Hong Kong, advises both Bank of China and Bank of Communications on corporate law and U.S. capital markets. She also advises Goldman on its investment in ICBC. London-based firms are in on the action, too. Linklaters, led by Zili Shao in Shanghai and Simon Davies in Hong Kong, is the Hong Kong capital markets counsel to Bank of Communications, not to mention corporate counsel to both UBS AG and Royal Bank of Scotland. Herbert Smith, anchored by Jeremy Xiao in Beijing, is the Hong Kong capital markets adviser to both CCB and ICBC, and gave counsel on inbound investments to China’s state bank holding company, known as Central SAFE Investments Limited. The impetus for the bank shake-up is China’s obligation under the World Trade Organization to give foreigners increased market access by the end of 2006. Although Western banks will be free to open their own branch networks, the country is impossibly large, and Chinese regulations limit them to opening in one city per year. Foreign banks are betting that a noncontrolling stake in a Chinese bank with thousands of its own branches will prove to be a meaningful foothold. The Chinese, meanwhile, are eager to suck in foreign capital, management expertise, and credibility with investors. The deal pattern was set by Bank of Communications, the largest Chinese bank that is not state-owned. London-based HSBC, which fancies itself the “local bank to the world,” bet $1.8 billion on “BoCom” in the summer of 2004. That paved the way for an oversubscribed IPO a year later. The lesson was clear, according to Bersani. “For a China bank IPO,” he says, “the key to success is to attract a brand-name Western bank as an investor.” Helping a Chinese bank to auction itself is where Anthony Root comes in. The lawyer who did the documentation for CCB’s sale to Bank of America is a certifiable prince of the U.S. establishment. A Root ancestor commanded the minutemen who fired the shot heard round the world. A great-great-uncle, Elihu Root Sr., was secretary of State under Theodore Roosevelt, and godfather of the Permanent Court of International Justice. The prototype of the lawyer-statesman, Elihu Root also founded the firm that became Winthrop, Stimson, Putnam & Roberts. Anthony’s great-uncle, Elihu Root Jr., was a founding partner of Cleary Gottlieb Steen & Hamilton. Anthony’s father, Oren, launched Root, Barrett, Smith, Shapiro & Simon. And the family helped to endow the Root-Tilden-Kern public interest scholarships at New York University. “I grew up with the idea that law is the intellectual glue that keeps the country together,” says Root. And that, paradoxically, is what draws him to Asia. New Yorkers have forgotten that law is a higher calling, Root laments. Yet the expat lawyers of Asia are building new societies, with all the faith and idealism of his legendary uncle. “In Asia,” Root says, “we’re the missionaries of capitalism.” Root settled in Hong Kong in 1993. He helped to open a local office for Davis Polk, then for Rogers & Wells in 1995, before settling at Milbank in 1996. His first major deal in Asia proved key to his future, by forging lasting ties with China Construction Bank. From 1994 to 1996, Root advised Morgan Stanley on a joint venture with CCB to form China International Capital Corp., in essence creating China’s first international investment bank. Root’s job, as he sees it, is to teach his clients international models. That can mean explaining directors’ indemnity agreements. Or challenging his clients’ conception of the lawyer-client relationship. There were moments in the negotiations when Root would concede that Bank of America had a legitimate concern. At first CCB executives would glare at Root, and suspect him of taking the “U.S.” side. (In a similar moment, Bersani recalls a Chinese CEO calling him a “running dog of capitalism.”) But in time the U.S. lawyers won the trust of their clients. “I’ve been in international finance 30 years, and these guys have been doing it five years,” Root says. “For their financial age, they’re doing extraordinarily well.” The Chinese financiers, who tend to be young in biological age too, need to be precocious if they’re to solve China’s vast banking problems. The big four “banks” began as agencies that the Communist party used to funnel money to favored projects, with no credit officers — and often no credit standards. The result was an endless sheaf of loans that will never be repaid. With the booming of the economy, the banks’ choice of projects to finance has been further distorted by local corruption. Greased thumbs press the green light for highways to nowhere and needless airports in tertiary cities. “Corruption and nonperforming loans are both linked to bad local government,” says former banking consultant Laurence Brahm. “That is the major crisis facing China today.” Making the banks solvent has required mind-boggling sums. Since 1998, China has transferred more than a quarter-trillion dollars in bad loans from the four major state-owned banks to state-created asset management companies. Over the same period, it has injected into the four banks nearly $100 billion in cash from China’s foreign exchange reserves. But asset management is no macroeconomic solution, argues Nicholas Lardy of the Institute for International Economics. For the most part, the asset managers merely shift shoddy loans off the books of the banks that are going public, leaving the debts to be covered by the government at some point in the future. Meanwhile, many banks have met state targets to reduce the percentage of bad loans by willy-nilly issuing new loans that will be classified as bad when they fall due. That’s especially likely if, as Lardy suspects, China is due for a cyclical slowdown in growth. Experts agree that the system will demand more injections of cash; the only question is how massive they will be. Eliminating corruption is another Sisyphean task. China Construction Bank’s employee mantra, posted on its Web site, declares that “Greed, deprav[ity], and corruption will bring shame to myself, my family, and my CCB.” Staffers ignore this creed at their peril, as Chinese bankers are frequently sentenced to death for fraud, and sometimes executed. Even the last two presidents of CCB have stepped down in disgrace, prompting The Economist to dub it the China Corruption Bank. CCB president Wang Xuebing was sentenced to 12 years in prison at the end of 2003, for improprieties that Chinese courts say he committed as head of Bank of China’s New York office from 1988 to 2000. His replacement at CCB, Zhang Enzhao, didn’t last long. A miffed vendor has filed a lawsuit in Monterey County, Calif., alleging that Zhang awarded a software contract to a rival — in return for cash and a golf junket to Pebble Beach. The rival firm denies the allegations, but Zhang resigned in March and is under investigation by Chinese authorities. Will Bank of America get an MSG headache after its Chinese feast? Perhaps. But the mandarins of Charlotte apparently believe that international listing and investment are the ultimate banking reform. The Western answer to bad loans is robust growth, combined with robust new credit approval processes. Lardy, for one, grants that CCB and Bank of China have become more selective in issuing new loans. The Western antidote to corruption (at least for opponents of the death penalty) is to appoint independent directors, make frequent disclosure, adopt international accounting standards, and impose tough internal controls. Anthony Root has no doubt about the purifying power of Western capital. In August he returned to CCB’s Beijing headquarters to coach managers on a presentation to the board, which now includes a woman banker from New York. Beaming at his client’s professionalism, Root seemed at ease in the unadorned offices. Even as China finds its way in finance, Root is finding his bearings in Beijing. That’s a good thing, because Root is set to launch a Milbank office there. The ur-American lawyer is opening a mission of capitalism in the capital of Communism. Related information: Chart: Am Law Global 100 (free registration required) Here Comes China Chart: U.S. Firms in China

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