From South China Morning Post:
The central government and foreign banks are threatening legal action against each other in an escalating row over ballooning losses racked up by state-owned airlines which ran into the red on derivatives contracts. Air China, China Eastern and Shanghai Airlines have reported losses of almost US$2 billion since last year on aviation fuel-hedging contracts after taking wrong-way bets on oil prices with their banks.
The State-owned Assets Supervision and Administration Commission (Sasac) said in a statement yesterday it would conduct an internal investigation into the contracts banks sold these airlines. “The purpose of the move is to protect our own interests by resorting to legal actions in commercial activities,” the statement said. Individuals familiar with the commission’s thinking said it might take legal steps to force the banks to forgive the losses.
Beijing’s hardline stance on what the banks consider a bread-and-butter activity of selling a simple product has rattled global financial institutions and world commodities markets. In Hong Kong, banks including Citi Goldman Sachs, JPMorgan and Morgan Stanley regularly sell these derivatives to mainland companies. The products are commonly sold all over the world to international airlines and multinationals whose profits are affected by oil prices.
“The Sasac’s message is clear: the government will do its part to help default on some of the contracts,” Yongan Futures Brokerage analyst Huang Lei said.
But in what he described as the central government “trying it on”, a well-placed executive at an investment bank in Hong Kong said: “Do not forget these contracts are enforceable under international law”.
Analysts dismissed both sides’ threats as rhetoric.
While the commission is threatening legal action, banks are more worried about ruining relations with Beijing and losing access to lucrative mainland banking licences. The banks must balance this by not being seen to roll over, inviting a flood of refund claims from firms whose own derivative bets went the wrong way.
“The potential Sasac-backed probe and litigation against the investment banks over the hedging contracts is groundless and unprecedented,” said Kelvin Lau, a transport analyst at Daiwa securities SMBC.
China Eastern, which incurred 6.2 billion yuan (HK$7 billion) of fuel-hedging losses last year, said it had not written to investment banks to renegotiate terms of fuel-hedging contracts. Shanghai Airlines, which hedged 4 per cent of its fuel consumption last year, said the board had not yet discussed the contracts.
Let me see if I understand this right. Chinese airlines use a common and widely used forward contract to hedge against changing fuel prices. Due to incompetence, and their top managements inability to act in time, they lose massive amounts of money. Rather than taking appropriate action and fire the useless airline management which is responsible for this screw-up, the government and their ‘commissions’ try to bully the banks now into compensating them for their own airline’s stupidity and incompetence.
Of course this kind of mafia practices by governments is not only limited to China. But in China it starts to become a familiar pattern to bully foreign companies around (like in the recent arrest of a number of Rio Tinto employees, and in fact holding them hostage). Foreign businesses should ask themselves, if a long term profitable business operation is feasible at all in a country that is being run in such an irrational and fraudulent way, and which is still a far cry away from any rule of law. China has never offered a level playing field to foreign business, but the recent trend should be seen as a warning for what’s still to come here.