* State-owned firms may default on commodity hedges -
* Bankers dismayed, confused by report; seek more details
* Lawyers question legality of the move
* Traders suspect lurking losses may have prompted warning
(Adds analysts comments)
By Eadie Chen and Chen Aizhu
BEIJING, Aug 31 A report that Chinese
state-owned companies will be allowed to walk away from
loss-making commodity derivative trades provoked anger and
dismay among investment bankers on Monday as they feared it may
set a damaging precedent.
The State-owned Assets Supervision and Administration
Commission, the regulator and nominal shareholder for
state-owned enterprises (SOEs), told six foreign banks that
SOEs reserved the right to default on contracts, Caijing
magazine quoted an unnamed industry source as saying in an
article published on Saturday.
While the details of the report could not be confirmed, it
was Monday's hot topic in financial circles from Shanghai to
Singapore as commodity marketers feared that companies holding
underwater price hedges could simply renege on the deals,
costing banks millions of dollars in profit.
The warning from SASAC follows a series of measures from
Beijing this year to crack down on the sale of derivative
products by foreign banks to Chinese enterprises, principally
big consumers, who bought protection against higher prices last
year only to watch the market collapse -- leaving them with
While many companies including top airlines have come clean
on the losses, some analysts fear another wave may follow.
"I wouldn't be surprised if more state firms emerge with
big derivatives trading losses, otherwise SASAC wouldn't come
out with such a radical move," said a Hong Kong-based
derivatives analyst, who like most other industry officials and
bankers declined to be named due to the high sensitivity of the
A SASAC media official said on Monday that he was waiting
for the "relevant department's" official comment before he can
clarify to media. A government official said that the Bureau of
Financial Supervision and Evaluation under SASAC was handling
the issue. The official declined to be named and did not
Spokespersons at Goldman Sachs (GS.N) and UBS UBSN.VX
declined comment, and media officials at Morgan Stanley (MS.N)
and JPMorgan (JPM.N) were not immediately available for
comment. All are major global providers of commodity risk
No bank were named in the Caijing report. The SASAC media
officer also declined to identify any specific banks.
"It's a handful of companies who are being encouraged by
regulators to re-negotiate," said a second banking source.
"It's outrageous, but it's China, so everyone is treading very
For banks that are hoping to sell more derivatives hedges
in China, the world's fastest-expanding major economy and top
commodities consumer, the danger goes beyond the immediate risk
to existing contracts to the longer-term precedent that
suggests Chinese companies can simply renege on deals when they
The report follows an order from SASAC in July that
required all central government-controlled state companies
engaged in trading derivatives to make quarterly reports about
their investments, including details of holdings and
But the reported letter opened several important questions
that could not immediately be answered.
"If we were among the banks receiving that letter, we would
be very angry. But now the key is to find out more details on
the letter: In whose name the letter was issued, the government
or the corporate's? And under what was the reason for
defaulting?" said a Singapore-based marketing executive with a
The source, whose bank did not receive a letter, said that
Air China, China Eastern and shipping giant COSCO -- among the
Chinese companies that have reported huge derivatives losses
since last year -- had issued almost identical notices to
"If it's in the name of the government, the impact will be
very negative," said the source, who declined to be named.
Beijing-based derivatives lawyers said the so-called "legal
letter" has no legal standing -- SASAC as a shareholder has no
business relationship with international banks.
"It's like the father suddenly told the creditors of his
debt-ridden son that his son won't pay any of his debt," said a
lawyer from the derivatives risks committee of the Beijing
It's also unclear why Chinese state firms, which have
complained that their foreign banks sometimes did not disclose
full information of potential risks when selling them
complicated products, did not seek redress through the courts.
"If that is the case, these firms should seek through legal
measures to safeguard their rights, instead of turning to the
authorities for political interference," said a different
SASAC took over the job of overseeing SOEs' derivatives
trading from the securities regulator in February after several
Chinese firms reported huge losses from derivatives.
For a factbox of China's derivatives
(Reporting by Eadie Chen and Chen Aizhu in Beijing, Alfred
Cang in Shanghai, George Chen and Michael Flaherty in Hong
Kong; Editing by Jonathan Leff)