Chinese state-owned enterprises (SOEs) have lost huge sums on derivatives contracts, and the State Assets Supervision and Administration Commission (SASAC) website has confirmed that the Chinese government will 'support state firms through various legal methods and negotiations to minimize their losses'.
Earlier reports in Caijing magazine stating that the Chinese government would allow SOEs to default on derivative deals had reverberated through the markets since August.
On its website, the SASAC stated that it 'supported moves by unnamed Chinese enterprises to seek recourse for their losses in structured financial derivative contracts tied to the price of oil and reserved the right to file lawsuits itself.'
The losses to SOEs clearly pose problems for the authorities: Citic Pacific, the Hong Kong based offshoot of the state enterprise China International Trust and Investment Company, has announced potential losses of more than USD2bn on improperly hedged foreign exchange transactions, and several state owned airlines accumulated losses on fuel hedging contracts reported at the time to be almost USD2bn.
According to Caijing, almost all large state enterprises that engage in foreign trade are involved in derivatives contracts, nominally worth about RMB1 trillion (USD146bn), with the bulk of the contracts involving crude oil, non-ferrous metals, agricultural goods, iron ore and coal.
The SASAC and the National Audit Office are reported to have been investigating SOEs' derivatives positions since the beginning of the year.
A new regulatory framework affecting banks established in China is expected to be introduced from September 16 designed to limit the risks associated with the marketing and trading in derivatives.
The China Banking Regulatory Commission (CBRC) has issued a "risk signal" to Chinese banks, requiring them to strengthen the management of risks inherent in derivatives transactions. The move intends to put the banks on guard against the credit risks, market risks, liquidity risks, operational risks and legal risks arising from derivatives transactions.
To this end, the CBRC announced that it will license banks to conduct such business and monitor their risk management functions. Any banks conducting derivatives transactions without the authorization from CBRC risk penalties, and the bank officials involved will face legal proceedings.
Like its Western counterparts, the CBRC wishes to restrict trading to over the counter or standard products, where over time the risk is comprehensible, quantifiable and easier to monitor. The products must also be marketed in such a way that the customer understands the contract and it addresses specific customer needs.
Observers have warned, however, that such strict regulation coupled with a history of default could severely limit the scope of western institutions to operate in the China market. The five largest commercial banks in China are reported to be pressing for the imposition of very high capital requirements on foreign banks that wish to trade derivatives in China.
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