March 25,2009

SASAC Cracks Down on Speculative Derivatives Deals by SOEs

By CSC staff, Shanghai
It is now apparent that Wall Street and its investment banks is not the only place where squirrely financial dealings have gotten out of hand. It has been revealed that even Chinese state-owned enterprises (SOEs) have gotten themselves involved some very speculative financial derivative transactions, to the tune of billions of yuan in losses.
In response, China’s State-owned Assets Supervision and Administration Commission (SASAC) of the State Council has come down hard. On Tuesday it issued new regulations, banning central SOEs from speculation and ordering them to stick strictly to the hedging principle and submit timely report on derivative positions.
Audits of enterprises involved in unauthorized derivative transactions have uncovered huge losses. SASAC says it will punish the leaders of some who are responsible for the losses.
Since the second half of last year, as the spread of the global financial crisis has gotten everybody jumpy, a group of central SOEs, including China Ocean Shipping (Group) Company, China Eastern Airlines, and Air China, have been forced to report excessive losses from such dealings.
SASAC is not banning all financial derivative transactions, but now requires central SOEs to make careful use of financial derivatives, sticking to the hedging principle and avoiding all kinds of speculative transactions.
SASAC requires that central SOEs?hedging transactions must be simple derivatives, closely related to their main business, and must meet accounting requirements for the treatment of hedging. Meanwhile, drawing a lesson from earlier SOE financial fiascos due to lack of knowledge or experience in complicated derivative transactions, SASAC is banning central SOEs from conducting any complicated transaction without clear risk and price.
Even in their main business, enterprises can easily transform hedging transactions into speculative ones. In 2004, the Singapore branch of China National Aviation Fuel Group (CNAF) dropped $550 million when it took risky bets on oil derivatives. SASAC is now emphasizing that spot transactions must be the basis for SOEs?hedging.
SASAC requires that no hedging contract may exceed 90 percent of the value of the covered spot goods, and that hedging positions should be held for no longer than 12 months, or the length of the spot contract, whichever is shorter. Hedging contracts by enterprises that have incurred losses in past derivative transactions or have just begun to transact derivative transactions should cover no more than 50% of the value of spot goods in the following two years.
After CNAF discovered the losses in its Singapore branch, its management did not report to the government and settle their positions immediately, but tried to cover up and correct the situation, leading to even greater losses. SASAC now requires enterprises to report their positions in a timely manner. Important issues, such as significant losses, must be reported within three working days.
Now central SOEs are reviewing their derivative business, including futures, options, forwards, swap contracts, and overseas derivative products bought from banks. According to SASAC’s directive, business without present government authorization must be settled as soon as possible, and enterprises without authorization are not allowed to start any new derivatives business.
SOEs must pay special attention to existing business with high risk or large book loss, and must cut or settle their positions and cut losses. They must also reinforce supervision over large scale and long term hedging transactions that have not yet seen book losses but may lead to greater risk and uncertainty, and cut their positions where necessary to avoid losses.



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