China Blames Foreign Banks for Derivatives Losses

(Bloomberg) -- A Chinese official said “fraudulent practices” by some foreign investment banks were partly to blame for more than 11.4 billion yuan ($1.67 billion) of derivatives losses at Chinese state-owned companies last year.

“Some international investment banks were the culprits behind the derivatives Waterloo suffered by Chinese companies,” Li Wei, vice chairman of the State-owned Assets Supervision and Administration Commission wrote in an article in the Study Times, a newspaper published by the Party School of the Central Committee of China’s Communist Party. The state assets commission oversees companies owned by the central government.

Sixty-eight companies including China Eastern Air Holding Co. and China National Aviation Holding Co. lost money on derivative products sold by banks including Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch & Co. and Citigroup Inc., Li wrote in the Nov. 30 article. He didn’t say which banks may have used fraudulent practices.

Spokespeople at Goldman, Morgan Stanley, Merrill Lynch and Citigroup either declined to comment or weren’t immediately available.

State-owned companies bought contracts linked to the price of oil and interest-rate swap products, Li wrote. The losses of 11.4 billion yuan were as of October last year.

Citic Pacific Losses

Citic Pacific Ltd. predicted as much as $2 billion in losses from unauthorized currency bets in a stock exchange filing on Oct. 20, 2008, prompting a 55 percent slump in the company’s shares. Citic, an investment company with interests in steel manufacturing and iron ore mining, asked for a bailout last year from its parent, state-owned Citic Group.

Shenzhen Nanshan Power Co. disputed oil-hedging contracts with Goldman Sachs that caused losses for the utility in December last year.

In one contract, Nanshan Power stood to gain as much as $300,000 a month if oil prices rose above $63.50 a barrel between March 3 and Dec. 31, and a loss if it fell below $62, the company said in October last year.

China has approved 31 companies to trade derivatives overseas, with 16 of them owned by central government. The companies’ pursuit of large profits, the complexity of the derivatives contracts, poor corporate governance and risk management at the companies, and a lack of sufficiently trained staff aggravate losses, Li wrote.

State-operated enterprises should use derivatives to hedge against losses, lock in future profit and minimize risks, Li said in the newspaper. Companies should be careful not to use derivatives to speculate and failure to use correctly pose “huge risks” to the economy, he said.