US embassy cable - 05TAIPEI3117

C O N F I D E N T I A L SECTION 01 OF 04 TAIPEI 003117 
 
SIPDIS 
 
DEPT PASS TO AIT/W AND USTR 
DEPT FOR EAP/TC, EAP/EP AND EB/IFD/OIA 
TREASURY FOR OASIA ZELIKOW,WISNER AND OCC AMCMAHON 
TREASURY ALSO PASS TO FEDERAL RESERVE BOARD OF GOVERNORS, 
SAN FRANCISO FRB AND NEW YORK FRB 
 
E.O. 12958: DECL: 07/08/2020 
TAGS: ECON, EFIN, PINR, PREL, TW 
SUBJECT: MIXED RESULTS FOR TAIWAN FSC'S FIRST YEAR 
 
REF: A. TAIPEI 2984 
 
     B. 04 TAIPEI 04050 
 
Classified By: AIT DIRECTOR DOUGLAS PAAL, REASON 1.5 B/D 
 
1.  (C) Summary: The first anniversary of the establishment 
of Taiwan's Financial Supervisory Commission (FSC) in July 
coincided with the removal of Lee Chin-chen as head of its 
investigative unit because of his suspected involvement in an 
insider trading scheme (ref a).  During a lunch with AIT on 
July 20, 2005, FSC officials accentuated the Commission's 
positive accomplishments in successful investigations, 
internationalization, and consumer protection.  They 
downplayed the irony noted by some U.S. business people that 
recent allegations of insider trading by FSC officials has 
increased rather than reduced doubts about the transparency 
of Taiwan's financial sector.  End summary. 
 
2.  (SBU) In July 2004, Taiwan consolidated regulatory 
authority over banking, insurance, and securities under the 
FSC in order to increase confidence in the local finance 
sector through more vigorous investigation of economic 
crimes.  Taiwan authorities reasoned that audits and 
examinations conducted by a single regulator with authority 
over the entire range of banking, insurance and securities 
products offered by financial holding corporations (FHCs) 
would provide more efficient and thorough supervision (ref b). 
 
No Disappointments with FSC,s First Year 
---------------------------------------- 
 
3.  (C) Director General for International Affairs Andrea Lee 
told AIT on July 20, 2005 that he had no major 
dissatisfaction with how the FSC had performed during its 
first year.  He listed several significant FSC 
accomplishments in recent months including the rapid and 
thorough investigation of several major white collar crime 
cases.  A second major FSC accomplishment during the first 
year has been promoting international awareness of Taiwan 
markets.  Direct portfolio investment increased by over US$ 
20 billion from 2004 to 2005.  The FSC has established a 
representative office in New York (and will soon have one in 
London) to improve its supervision of Taiwan financial 
institutions' overseas branches and provide direct 
communications with the headquarters of foreign financial 
institutions in Taiwan.  A third significant FSC 
accomplishment has been the greatly improved consumer 
protection created by new disclosure and truth-in-advertising 
regulations for financial institutions.  Another FSC official 
echoed the positive assessment and noted the improved 
efficiency and communications between banking, securities, 
and insurance regulators now that they were part of one 
agency. 
 
Swift and Strict Justice 
------------------------ 
 
4.  (C) DG Lee said the FSC has been more transparent and 
quicker in disciplinary actions than its predecessors.  It 
publishes planned measures, draft laws, and regulations for 
comment in advance.  It also publishes its actions.  For 
example, in the second half of 2004, the FSC suspended 
several CPAs, certifying authority for their failure to 
identify problems in a listed company's financial statements 
linked to a NT$6.3 billion embezzlement scandal.  In the 
past, no Taiwan CPAs has ever been penalized.  In the first 
half of 2005, following a quick investigation, the FSC 
penalized the chairman of a financial holding company 
(International Bills) for his company's involvement in money 
laundering.  The FSC also penalized another financial holding 
company (SinoPac) because its chairman concurrently served as 
chairman of numerous SinoPac's subsidiaries.  A penalty of 
NT$2 million was given a bank for setting up offices without 
prior permits.  A credit card company was fined NT$1 million 
for selling customers, credit information to other financial 
firms. 
 
5.  (C) Lee continued describing FSC efforts to make listed 
companies more transparent.  The FSC began in Q1 of 2005 to 
require listed companies to publish their investment in 
China.  In addition to quarterly, semiannual, and annual 
financial reports, listed companies are also now required to 
project their future performance.  The FSC has published and 
posted on the internet such key financial data as the 
non-performing loans (NPL) ratios, bad debt reserves, capital 
adequacy ratios, and rates of return for all Taiwan banks, 
credit coops, and trust companies. 
 
Deregulation, International Standards 
------------------------------------- 
 
6.  (C) The FSC, according to Lee, has spared no effort to 
deregulate and meet international standards.  In January 
2005, it adopted a &negative list8 system under which 
financial institutions are no longer required to obtain prior 
permission before offering new financial products.  Foreign 
portfolio investors are no longer required to obtain prior 
permission for investment in Taiwan.  In response to foreign 
portfolio investors, complaints about listed companies 
distributing profits to employees, the FSC began in the 
second half of 2004 to set restrictions on such profit 
sharing.  The FSC plans to relax the daily stock price 
fluctuation limits from 7% above or below the closing price 
of the previous day to 15%.  The FSC has promoted 
implementation of the new Basel Agreement by Taiwan's banking 
community.  The FSC has translated and published the new 
Basel Agreement in Chinese.  Banks are required to meet the 
new requirements in July 2005.  International definitions of 
NPLs are now used in Taiwan. Lee said that as a result of the 
FSC,s several carrot and stick measures, NPLs were reduced 
by 22% to NT$577.8 billion in May 2005 from NT$740.5 billion 
at end of June 2004.  During the period, the average NPL 
ratio dropped from 4.9% to 3.6%.  The capital adequacy ratio 
in December 2004 rose to a four-year high of 10.7%. 
 
Damage from Insider Trading Scandal 
----------------------------------- 
 
7.  (C) However, Tim Yang (Wei-wen) senior counsel for 
PriceWaterhouseCoopers in Taiwan told AIT there could be 
widespread damage to Taiwan's entire financial sector if 
media coverage of the Power Quotient International (PQI) 
insider trading scandal leaves the impression of official 
corruption or of rigged trading on Taiwan's stock exchange. 
The impact on Taiwan's ability to attract and hold foreign 
direct portfolio investment and attract foreign investors to 
state-owned companies could be significant.  Yang also noted 
that the FSC,s loss of authority over state-owned financial 
institutions to the Ministry of Finance (MOF) had lessened 
the FSC,s influence on financial reform. 
 
8.  (C) Yang thought the most significant change brought 
about by the establishment of the FSC was consolidation of 
auditing and inspection authority from various regulatory 
agencies in the past to an &Examination Bureau8 (EB). 
Until the allegations of EB DG Lee Chin-chen's involvement in 
the PQI insider trading scandal became public, it was widely 
believed that the FSC had succeeding in being more 
transparent and effective than its predecessors, Yang said. 
That conclusion now seemed suspect. 
 
Organization 
------------ 
 
9.  (SBU) The establishment of the FSC upgraded Taiwan's 
financial regulatory authority to ministerial level.  The FSC 
chairman is a cabinet member devoted to financial regulatory 
duties.  Prior to July 2004, financial regulation was handled 
by bureau directors reporting to the Minister of Finance, who 
had duties covering financial regulation as well as taxation, 
national properties and fiscal resources. Under the FSC, 
auditing and examination authority were concentrated in the 
EB.  The Bureau of Monetary Affairs (BOMA), Insurance Bureau 
(IB), and Securities and Futures Bureau (SFB), all now part 
of the FSC, no longer audit or inspect financial institutions 
and have transferred their auditors and examiners to the EB. 
The Central Deposit Insurance Corporation also ceased 
inspecting deposit-taking institutes, and all of its 
inspectors moved to the EB.  The Central Bank of China keeps 
some examiners for inspections related to monetary policy and 
foreign exchange issues, while the rest were reassigned to 
the EB.  A new office known as Division 6 was set up within 
BOMA specifically to supervise FHCs. 
 
Ostensibly Independent Commissioners 
------------------------------------ 
 
10.  (C) The FSC Commission is composed of nine members, all 
of whom were academics or business executives prior to their 
appointments.  Lin Chung-cheng is the only commissioner who 
was active in the ruling Democratic Progressive Party (DPP) 
before his appointment.  FSC Chairman Kong Jaw-sheng is not 
officially a DPP member although he was known as a DPP 
supporter prior to his appointment as FSC Chairman.  Vice 
Chairman Lu Daung-yen used to be SFEC Chairman.  Vice 
Chairperson Susan Chang was BOMA Director before she was 
promoted to Director of the MOF Treasury Department and 
subsequently as Vice Finance Minister.  The remaining five 
FSC commissioners have strong professional backgrounds.  Lee 
Shyan-yuan was a professor teaching courses in bonds and bond 
markets at National Taiwan University (NTU).  Wu Chung-fern 
was teaching at the Fisher School of Accounting in the United 
States before she returned to teach at NTU.  Chin Wen-yueh 
used to be a merger and acquisitions lawyer practicing law in 
New York State before she returned to join a local law firm. 
Ling Kuen-bao had been President of the Taiwan Life Insurance 
Company and Huang Hsien-hwa had been CEO of Barits Securities 
Company, a large underwriting firm. 
 
Independence Challenged by Executive Branch 
------------------------------------------- 
 
11.  (C) The independence of the FSC has been undermined in 
several ways:  The FSC has to report to the Executive Yuan 
(EY), and Chairman Kong Jaw-sheng attends all regular cabinet 
meetings.  A few months after the inauguration of the FSC, 
the EY reassigned overall oversight responsibility for 
state-owned financial institutions from the FSC to the MOF. 
(The FSC still has regulatory responsibility, but now lacks 
the authority to order these state-owned financial 
institutions to accept merger or privatization offers.) The 
EY is currently weighing whether the FSC should have any 
policy-making authority.  On some occasions, the FSC has 
compromised its independence to go along with executive 
branch policy.  In March 2005, the EY adopted a set of 
economic stimulus measures, including a promise to provide 
loans of NT$100 billion to small and medium enterprises 
(SME).  To facilitate this, the FSC offered banks achieving 
better SME lending performance a waiver of its ban on setting 
up new branches. 
 
12.  (C) In October 2004, President Chen Shui-bian announced 
second-stage financial reform goals including reduction by 
half of the number state-owned banks prior to the end of 2005 
and reduction by half of the number of all (both state-owned 
and private) FHCs prior to the end of 2006.  However, the 
loss of authority over state-owned financial institutions 
(the government has significant stakes in six of Taiwan's 14 
FHCs) has compromised the FSC,s capability to promote 
financial consolidation. 
 
...as Well as by Legislative Branch 
----------------------------------- 
 
13.  (C) The FSC is also supervised by Taiwan's Legislative 
Yuan (LY).  FSC Chairman Kong and his senior staff report 
regularly to relevant committees and to the floor of the LY. 
The LY has repeatedly cut funding for the FSC, undermining 
its capabilities.  The LY has provided barely 10 percent of 
funding requested to extend the life of the Financial 
Reconstruction Fund (FRF), a mechanism similar to the RTC of 
the United States, well short of funding needed to resolve 
existing problems at financial institutions. 
 
Confrontation with MOJ 
---------------------- 
 
14.  (C) The PQI insider trading scandal generated a 
mud-slinging match between the EB and the Ministry of Justice 
MOJ) with each side publicly accusing the other of 
corruption, and mutual refusal to cooperate in the 
investigation (ref a).  At a meeting with AIT on July 21, 
2005, MOJ Prosecutorial Affairs Director Tsai Ching-hsiang 
downplayed the conflict, saying it was the direct result of 
evidence of EB involvement in the PQI scandal.  He said that 
the MOJ and EB had worked together in investigating other 
economic crime cases, and the MOJ's refusal to work with it 
on this case was not part of an attempt to diminish the EB's 
authority to investigate. 
 
15.  (C) FSC Chairman Kong told AIT Director recently that he 
was confident that the FSC and its EB had weathered the 
controversy over their authority with their credibility 
largely intact.  Kong said he learned valuable lessons as a 
novice dealing with Taiwan's media, including the need to be 
seen to act quickly when allegations arise. 
 
16.  (C) Comment: Even if EB DG Lee is proved innocent and 
full cooperation between the two agencies restored, it is 
still unclear whether the FSC has in fact put the PQI scandal 
behind it or whether MOJ leaks to the press have damaged the 
EB's credibility and capability to perform its duties.  While 
the FSC has accomplished a great deal in its first year, it 
may take some time to overcome this latest blow and restore 
confidence in Taiwan's financial sector.  A five member team 
of U.S. Federal Reserve System officials will be in Taiwan 
July 24-29 to conduct an assessment of the regulatory 
environment.  While their visit has no connection with the 
PQI scandal, but rather is due diligence prior to approving 
expanded operations by Taiwan financial companies in the 
United States, their evaluation of the situation should be 
instructive.  End comment. 
PAAL