Due diligence prior to an IPO

Formerly a family business[pp152&153] with links to Macao[p62], China Flooring Holding, listed on the Hong Kong stock exchange during May 2011. It is one of China's large wooden flooring groups,

Investment banks assisting in this IPO include HSBC and Morgan Stanley. The US$50 million equity investment which Morgan Stanley made during 2008 in China Flooring (through a joint initiative with the International Finance Corporation), and the fact that one of Morgan Stanley's Asia team is a director of China Flooring are presumably not a conflict of interest). HSBC helped arrange the IPO of Samling Global whose prospectus was criticised for failing to alert prospective shareholders to the nature and extent of illegality allegedly associated with Samling's business in Guyana, Sarawak and elsewhere.

The group conducts its business( including under the brand name Nature) in the USA (where it has a marketing office) and the European Union in the context of amendments to the Lacey Act (which, amongst other things, makes possession of illegal wood-based products within the USA an offence) and a regulation, to be applied from the third of March 2013 but already in force, which makes it an offence to be the first "operator" to place illegal wood-based products on the EU market. The regulation additionally requires operators to carry out due diligence to minimise the likelihood that those products are illegal. The group appears to import at least some of its products into the USA directly from Peru.

Solid wooden flooring accounts for roughly 20% of the group's sales.[p2] The great majority of this is made by authorised manufacturers on an exclusive basis[footnote 2, p1] - compounding the difficulty of ensuring that the wood used is legal. In terms of retails sales value, the group supplies roughly 7% of the solid wood flooring sold in China.

Wooden flooring made from (or whose surface layer is of) hardwood grown in Russia or tropical forest is particularly likely to be illegal (and from an unsustainably managed forest) unless supplied with a full chain of custody under a credible scheme certifying the management of the logging concession. Remarkably, no allegations have been made against any supplier of wooden flooring under the Lacey Act, despite clues such as the species name and country of origin being required in import declarations.

To mitigate this risk, China Flooring has been a member of the China section of the Global Forest and Trade Network (managed by WWF) since 2005. The FTN requires members to meet targets concerning the proportion of their sales which is credibly certified by specified dates. Although the two major flooring groups which are members of the China FTN do not appear to have met their targets,[Nature A&W "Anxin"] this has not triggered forfeiture of their membership.

The investment which Morgan Stanley and the IFC made in China Flooring was likewise conditional on targets for certification being met. It was also intended to support the group's interests in land adjacent Poyang lake (a Ramsar site) and improve the group's scrutiny of its sources of supply in Peru - where the group has a major presence, a mill, ownership of at least one logging concession [Yaverija Nature] certified under the Forest Stewardship Council scheme.[Key Issues & Mitigation] and a carbon credit.

The group appears to have rights to standing timber in Yunnan [p4] a region which whose timber sector has become notorious [Asia Pulp & Paper Sino-Forest GlobalWitness].

As a leading procurer of timber from Peru, China Flooring is well placed to advise why almost all the timber which is declared in China as imports from Peru under the customs code for sawn wood (HS 4407) while most of that same timber was exported to China from Peru as mouldings (HS code 4409). World Customs Organisation rules prohibit the use of different codes for the same product - as presumably do rules pertaining to FSC chain of custody certification. If the same level of tax or duty is applicable to sawn wood and mouldings, then there would be no suspicion of fraud.

The group is said[Slide3] to have a contract to procure timber from an enteprise which is listed on the Hong Kong stock exchange - Sustainable Forest Holdings - which changed its name and core business a number of times last decade and which gives the impression that has substantial interests in the timber industry in Russia and Brazil. There are doubts as to the extent of its assets in Brazil, notably in Rondônia[§4 p(iii)] and Acre.

Trading in the shares of a timber company (China Forestry Holdings) listed on the Hong Kong stock exchange has been suspended since early 2011 due to accounting and other irregularities, despite the equity interest of two international private equity firms. One might conclude from this that companies in which prestigious investors have a substantial equity stake are not necessarily robust or transparent.

During 2011, the shares of other companies operating in China's forestry/timber sector have been suspended or their price has crashed - subsequent to allegations or evidence of irregularities (Sino-Forest and Cathay Forest)