5 December 2009

China denounces U.S. banks for 'evil intent' with derivatives

Outside vanilla derivative products their sole function is to flog off hidden risk. The western banks mentioned monitised their cred and died, end of story.

BEIJING -- A senior Chinese official who oversees the country's largest state-owned enterprises has publicly slammed Western investment banks for "maliciously" peddling complicated derivative products that caused huge losses for Chinese companies over the last year.

In Beijing's strongest criticism on the matter to date, Li Wei, vice director of the state-owned Assets Supervision and Administration Commission, singled out Goldman Sachs, Morgan Stanley, Merrill Lynch, and Citigroup in a long and highly critical article in the latest issue of an official Communist party newspaper.

The large losses suffered by Chinese state companies were "closely associated with the intentionally complex and highly leveraged products that were fraudulently peddled by international investment banks with evil intentions," Mr Li asserted. "To a certain extent some international investment banks were the chief criminals and the root of ruin for the Chinese enterprises who encountered this financial derivatives Waterloo."

In his article, Mr Li said 68 of the 130-odd state companies controlled directly by Sasac had been buying derivatives to speculate or hedge against rising commodity prices and fluctuating currencies and interest rates, even though some of them were not authorised to do so.

These 68 companies had booked total combined net losses of Rmb11.4 billion on the Rmb125 billion worth of financial derivatives products they had bought by the end of October 2008, Mr Li said.

The government has not previously revealed the full extent of losses suffered by Chinese companies that made ill-fated bets on over-the-counter, mostly offshore derivatives.

In September, Sasac warned that some of the contracts were illegal and might be invalidated, a move that prompted some Western banks to agree quietly to renegotiate contracts behind closed doors.

Air China, China Eastern Airlines, Cosco, China Railway Engineering Corp., China Railway Construction Corp., and Citic Pacific were among the companies that lost the most from buying complex derivatives.

Some of the biggest losses came from the airlines and shipping companies' purchases of options to hedge against rising oil prices between June and August last year, when oil hit a historic peak of more than $140 a barrel.

When prices fell during the financial crisis, these companies were saddled with large losses, partly because they had chosen riskier -- and cheaper -- derivatives products to hedge against rising prices.

Mr Li said the most important reason for the derivatives losses was unnecessary speculation and attempts at arbitrage by these state companies.

He also cited weak risk management procedures, a lack of expertise, and intentional breaking of rules that restrict most kinds of financial derivatives in China.

But he said China should "not give up eating for fear of choking" and that it was imperative for Chinese companies to keep using financial derivatives.

No comments: