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Black swan event? China cancelling derivative contracts

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September 03, 2009 – Comments (2) | RELATED TICKERS: JPM , GOLD , SLV

Check out this article:

http://gata.org/node/7743

China's derivative default stance rattles banks

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 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 losses.

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 issue.

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 elaborate.

Spokespersons at Goldman Sachs and UBS declined comment, and media officials at Morgan Stanley and JPMorgan were not immediately available for comment. All are major global providers of commodity risk management.

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 renegotiate," said a second banking source. "It's outrageous, but it's China, so everyone is treading very carefully."

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 like.

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 performance.

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 foreign bank.

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 banks.

"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 Lawyers Association.

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 lawyer.

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.

 

Comment from Jim Sinclair:

Jim Sinclair’s Commentary

This is the single most important development in OTC derivatives since their inventors, Armstrong, Edeleman, Von Peterfly and Manko put them to use on interest sensitive investments in the 70s.

JFC - This appears to be a game of extremely high stakes poker. 

I look forward to some great FOOL discussion by those that perhaps are experts on derivatives.

FOOL ON!

JFC

 

 

 

2 Comments – Post Your Own

#1) On September 03, 2009 at 10:37 AM, cthomas1017 (83.47) wrote:

Great find, Jim!  This is certainly one that Sec. Clinton did not discuss "behind the curtains".  Not far from an outright declaration of financial war if you ask me.  I've been looking for a sign that China was changing its approach to its macro economic strategy, not the least of whcih is a radical departure from its purchase of longer term T-Bills.  This is a close second and forebodes what is to come with September's Treasury auctions.  I'd guess that in October, the Chinese will be wishing us that old Chinese curse, "May you live in interesting times."  October is going to be very interesting.

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#2) On September 12, 2009 at 2:37 AM, CyrusP (< 20) wrote:

I am excited of the announcement of Apple. Oh boy – another Apple announcement or "media event" for stuff we can buy that, if iTunes is any kind of reference point, will work slowly if at all, and people will pay a lot of money for it because they're that unfulfilled as people. At any rate, the Apple announcement is that they're unveiling a few things. There's Apple iTunes 9, and iTunes LP – which will include visual aids like liner notes for downloaded music. Steve Jobs was there, and he also announced updates to the Apple Store, which will tell you what applications to get. There's new iPods and other products to get, too, and each Apple announcement leads to people getting payday cash to buy more stuff.

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