(Beijing) -- After nearly three decades operation, Jiangsu-based Shagang Group, one of the country's largest private steel makers, is legitimate in the eyes of regulatory authorities.
Shagang is among the 45 steel companies that the Ministry of Industry and Information Technology (MIIT) said in early April had met regulations issued in 2012 to officially enter the industry. Fifteen of the companies are privately owned.
For many steel companies like Shagang the news is remarkable because it means finally getting full legitimacy from the regulator.
Over the past decade, encouraged by surging demand, China's steel refining capacity has expanded quickly. However, a lot of the newly added capacity, much of it privately owned, failed to get necessary approvals from government agencies.
For years, the companies operated in a regulatory grey zone and were vulnerable when the government launched inspections of the industry or initiated new policies.
These companies' worst fears came to pass in 2004, when privately owned Jiangsu Tieben Steel Co. was shut. That year, as the central government sought to rein in blind investment to prevent overcapacity and economic overheating, a special inspection team composed of representatives from nine ministries and commissions under the State Council conducted a comprehensive investigation of fast-growing Tieben.
Inspectors found that the company had illegally expanded since its founding in 1996. Tieben was closed and its assets were auctioned off. Dai Guofang, the founder and chairman of Tieben, was sentenced to five years in prison.
Thus, the MIIT's latest decision is seen as a long-anticipated step toward transforming supervision of the country's steel industry, replacing a system that required administrative approval with one that is defined by industry standards that regulate companies' operations.
Predictably, the change has been applauded by the industry. Analysts say the new method is more market-oriented and will transform the industry. Insiders say it will mean more room for private steel companies to develop.
A Long Journey
Since 2010, Shagang chairman Shen Wenrong has received several notices from government departments that the company had won approval from MIIT to operate in the industry. However, no official announcement was made before April.
"The first time we were told we had approval was in 2010, not long after the ministry issued a document on the regulations of steel industry operation," Shen said.
Industry insiders said the 2010 document issued by the MIIT was a step toward granting legitimacy to unapproved companies. But in November that year, the National Development and Reform Commission (NDRC), the Ministry of Land and Resources and the Ministry of Environmental Protection jointly issued a circular requiring that illegal steel production capacity be cleared up. This was a clear step against the MIIT.
"In 2010, the MIIT approved the first batch of companies, but kept this undisclosed mainly because of the resistance from the NDRC," a source close to the situation said. The MIIT agreed to grant legitimacy to all unapproved steel companies, the source said, but the NDRC disagreed. The country's top economic regulator believed such a move would hurt the government's credibility.
"It wasn't until late 2012 that the NDRC softened its position on controlling the unapproved capacity," the source said, adding that despite this, the commission has never expressed support for the MIIT's stance.
In September 2012, the MIIT revised its 2010 regulations. It deleted a requirement that steel companies provide registration and approval documents to the government, indicating the ministry was easing control over steel projects.
The government has long kept strict control over steel production capacity. However, surging demand over the past decade prompted a large number of steel plants to be built without government permission. The new projects involved both private and state-owned backing.
A 2010 survey by the MIIT found that of the 718 million tons of steel production capacity in the country that year, about 300 million tons lacked necessary approval.
"In the last ten years, steel industry policies have been mainly designed to control excessive growth of capacity," said Miao Zhimin, deputy director of the MIIT's Raw Materials Department. "Administrative approval has been the major supervision instrument to control new projects, land usage and bank loans.
"But companies encouraged by market demand have continued to expand capacity."
By the end of last year, the country's steel production capacity reached 1 billion tons, Miao said.
The ineffective administrative measures in place forced the MIIT to explore new methods of regulation, leading it to issue industry standards now in place. "We hope to explore new models of steel industry regulation," said Miao.
The updated standards cover various aspects, including product quality, environmental protection, energy consumption and safety.
An executive at a major steel company said the MIIT's standards were good news for private steel companies because they provided a path to legitimate operation.
Miao said 104 steel companies submitted materials to the MIIT last year in hopes of winning full legal status. "These companies represent a total of 387 million tons of production capacity, accounting for 60.7 percent of the national total," Miao said.
After the MIIT performed its review, it announced 45 companies, including Shagang, had met all the criteria.
The Tieben episode in 2004 forced steel companies, especially privately owned ones, to realize the risk they ran by operating without legal backing.
Before the State Council team was dispatched, the regulator had already halted a Tieben project to spend 10 billion yuan to increase production capacity by 8 million tons. Tieben was then accused of illegally acquiring land for the new project.
In April 2009, after years of trials, company chairman Dai was jailed for falsifying financial records and tax evasion. Tieben was liquidated.
Meanwhile, another private company, Ningbo Jianlong Steel Co., was also shut by the regulator for violations regarding a project and land deals. There were also environmental concerns.
"Both of the companies were close to us," a Shagang executive said. "At the time, Shagang had started building a hot coil production line with 6.5 million tons of capacity. Everybody was worried the project would be halted."
Shagang's hot coil project received approval from the State Council's Economic and Trade Commission, the executive said, but still lacked NDRC approval. An inspection team from the cabinet also investigated the project, but eventually granted a permit because Shagang's application documents and financial capacity were stronger than Tieben, the executive said.
However, the episode set off alarm bells at Shagang. "On the one hand, we were worried there would be another inspection. On the other hand, the operation faced mounting challenges."
The grey area Shagang existed in meant it was difficult to get bank loans and embark on a listing.
"There were many banks willing to lend money, but (after the inspection) we found it difficult to get a penny because they said it was risky to lend to an illegal project," the executive said.
There have not been any inspections as harsh as those in 2004, but the central government has launched several minor efforts aimed at consolidation and eliminating outdated capacity. The most frequent targets were, naturally, privately owned companies.
"When the market condition is sound, everything is fine for both state-owned and private steel companies," the manager of a private firm in Hebei said. "But if the market declines, the government will issue policies to limit private firms, such as limiting power supply."
A Step Forward
Miao said the MIIT hoped its industry standards covered 80 percent of the country's existing steel capacity by the end of 2015. The ministry will adopt measures to encourage mergers and restructuring to eliminate outdated capacity, and push forward with upgrading technology.
It will also encourage companies to reduce energy consumption and pollution by offering policy and credit support. Many executives at private steel companies applaud the approach.
A survey from the Metallurgical Industry Association shows that private steel companies have outperformed their state-backed counterparts. In 2012, private steel companies reported combined profits of 18.9 billion yuan, or 70 yuan of net profit for every ton of steel. The figure for state companies was 2.6 yuan.
"Previously, most of the mergers and acquisitions in the steel industry were launched by state-owned companies," said Liu Haimin, deputy director of China Steel Development & Research Institute. "Private firms agreed to be merged into weaker state companies mainly because the identity concerns."
Liu said once private companies received full legitimacy, many were capable of launching acquisitions.