China vs. Rio Tinto Execs: Why Confrontation Isn’t Over

China vs. Rio Tinto Execs: Why Confrontation Isnt Over

When the Chinese government announced earlier this week the formal arrest of
four Shanghai-based executives of global mining giant Rio Tinto — one
Australian citizen and three Chinese nationals — it seemed a deliberate
ratcheting down of a case that had stunned foreign investors in the country.
After all, Beijing had effectively dropped the case’s most ominous element:
the charge that Rio’s Stern Hu and his three colleagues had allegedly stolen
“state secrets,” in part by bribing executives of Chinese steel companies,
who are Rio’s largest buyers of iron ore. Under a state-secrets charge, the
four men faced the prospect of a secret trial and the possibility of
lifetime sentences. Now that the government will only charge them with using “improper means” to gain access to commercial secrets — commercial bribery — the executives will have access to legal counsel and should be able to mount a defense. Sam
Walsh, the iron-ore chief executive for Rio, went so far as to say that
since “the charges have been downgraded … I think that reflects what we’ve
been saying all along: that we don’t believe there’s any evidence of

It’s not likely to be that simple. Sources in China tell TIME that while
Beijing recognizes it overreached by originally alleging the theft of state
secrets, this week’s climbdown does not mean the government is looking for
a face-saving way out of the situation. Far from it, in fact. The case — just as many outsiders had assumed — is rooted in what one Chinese steel-industry official called the “sense of outrage at the highest levels in
Beijing” that Rio walked away in June from a $19.5 billion tie-up it had
struck late last year with Chinalco, the Chinese state-owned aluminum
company. To make matters worse, from Beijing’s perspective, Rio then turned
around and agreed to a joint venture in iron ore with global rival BHP
Billiton. Together the two control about 75% of the world’s iron ore, which
China’s steelmakers consume ravenously. “That deal is China’s worst
nightmare,” says an investment-banking source with close ties to the global
mining industry.

China’s response is three-pronged. First, the case against Hu and his Rio
colleagues, which Vice Commerce Minister Fu Ziying earlier this week
insisted will show foreign investors that China is “ruled by law now,” will
proceed. And while the industry insiders interviewed by TIME do not have
detailed knowledge of the specific charges likely to be brought against the
Rio executives, they describe the steel and mining businesses — in China
as well as other developing countries — as industries in which “side deals”
involving key principles like executives and government officials are
common. Despite Walsh’s assertion that there is “no evidence” against
the Rio execs, the widespread assumption among steel-industry insiders with
experience operating in China is the opposite — that the government will
likely be able to produce evidence that is not, as a source put it, “made
up out of whole cloth.”

China’s second tack is to prolong negotiations over the contract price of
iron ore with the two main suppliers, hoping to wear them down while
frantically moving to line up other potential sources beyond Rio and BHP
Billiton for next year and beyond. China is the world’s largest steel
producer, and despite the global recession, its factories are running
close to flat-out thanks to enormous infrastructure construction and brisk
sales for new autos and apartments. That means it would appear to have
little leverage in pursuit of the price cuts on iron ore that it seeks: a
45% reduction from last year’s record levels.

But there are different kinds of leverage. In June, when Rio and BHP
Billiton announced their intention to form a joint venture, a Ministry of
Commerce spokesman in Beijing said the proposal had “the obvious color of
monopoly.” China implemented a new antitrust law last year and has already
used it once to block a high-profile foreign acquisition in China — Coca-Cola’s planned buyout of juicemaker Huiyuan. The fact that the proposed
Rio–BHP Billiton deal doesn’t involve a Chinese firm is irrelevant.
China’s antitrust regulators have the same right to review the plans of two
global companies as the E.U. did to bring antitrust charges against Microsoft
in 2000.

Earlier this summer, many mining-industry analysts were skeptical that China
would actually act against the proposed Rio-BHP tie-up. They assumed the
Ministry of Commerce was just venting after the Chinalco deal failed. But a
banking source with close ties to the Australian mining industry says that
perception is wrong. “The antitrust review is real, and right now if I had
to bet, I’d bet that [the Rio–BHP Billiton iron-ore tie-up] doesn’t happen.
The Chinese are going to block it.”

Contrary to constant press reports in China and abroad, which say the
Chinese side of the iron-ore price negotiations are being conducted on
Beijing’s side by the Chinese Iron and Steel Association, they are, in fact,
being run straight out of Premier Wen Jiabao’s office. And Wen, says the
banking source, has “not been a happy man” since the Chinalco deal fell
apart earlier this summer. Don’t misread, in other words, the absence of the
state-secrets charge against the Rio Four as evidence that the extraordinary
face-off between China and one of the world’s most powerful global companies
is now tapering off. Wen has other cards to play, and the confrontation may
have only just begun.

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