For a Chinese company that
dreamed of everlasting prosperity, China Aviation Oil
(CAO) couldn't have been a worse name. In the Chinese
dictionary it is pronounced exactly the same way as a
popular vulgar word equivalent to the "f" word in
English. So when Singapore-listed CAO, with CAO as its
ticker symbol, collapsed after ringing up a US$550
million in losses, the collective reaction in Beijing
was an appropriate: "CAO is a royal Cao-up."
The
company was a heavy player in the energy markets. In
2003, trading accounted for 17% of its income and
industrial investments 64%. Details are still awaited on
just how an obscure overseas branch of a Chinese state
monopoly (its parent is the China Aviation Oil Holding
Co in Beijing) lost so much money in such a short time.
But the skeletons will jump out in due course as
Singaporean financial regulators are scrambling to
uncover the sordid workings that led to the fiasco.
Already PricewaterhouseCoopers has been appointed the
administrator of the failed company and its chief
executive, Chen Jiulin, who flew back to China
immediately after the announcement of the losses, has
been asked to come back to assist in the official
investigation. He has agreed to do so this week.
CAO placed large bets on a
downward direction of the world oil price in the
highly volatile derivatives and futures markets. But crude oil
rallied sharply instead. To recoup the huge loss in its
positions, it probably covered back its shorts and went long in
the belief that the market would continue on its
trajectory to the moon. Contrary to its wish, the oil
price retreated almost in a straight line, delivering
CAO a one-two punch. Unable to finance the margin
requirements, the company had no choice but to run to
the bankruptcy court for protection.
Financial
derivatives, commodity futures and options are highly
leveraged, high-stakes games with potentially unlimited
risks. But with millions of dollars flowing in and out
of a trading account at the stroke of a few computer
keys, arrogance becomes an occupational hazard.
Invariably, a sense of self-importance gets to the
trader's head and conjures up an image of himself larger
than life. Before Nick Leeson earned his notoriety
bankrupting his employer with a $1.2 billion trading
loss, he was a star rainmaker in Britain's prestigious
Barings bank. Another commodity trader in Sumitomo was
so successful he was dubbed Mr Three Percent for his
awesome power in moving and shaking the world copper
market. Then the guy overreached himself and ended up
losing $2.6 billion for the Japanese firm.
CAO's
Chen is cut from the same cloth. He was instrumental in
turning around the small outfit and building it up into
a force to be reckoned with in the Singapore market. And
he made no secret of his contentment and ambition when
he said in an interview in March to a Chinese magazine,
"Gambling is probably part of human nature. Often I
would apply a certain amount of gambling spirit to the
development of my company. CAO's bets are all gambles
with an absolute guarantee of success." In the end,
though, the house brought down the gambler.
Still, rogue traders wouldn't have done so much
damage to their employers and themselves (Leeson served
five years in a Singaporean prison) unless the
management let them. Here, the issue of corporate
governance comes once again into sharp focus. In a
sense, these companies had it coming because of the
scarecrow-like in-house regulations. The CAO mess
revealed just how much its parent company in Beijing
must do to improve its oversight. But then, this parent
isn't exactly a model corporate citizen itself. Just
days before the announcement of CAO's demise, China
Aviation Holdings Co sold a 15% stake of its
Singapore-listed subsidiary in a private placement
arranged by Deutsche Bank on October 20. The transaction
violated about every rule in the book against insider
trading and disclosure - would anyone believe that the
holding company was not aware of the back-breaking
losses in the subsidiary that it was selling? When a
fish's head stinks like that, the tail won't be very
delicious either.
So much for great expectations
of good governance. What about accountability? In other
words, who will pick up the pieces and the bill?
Contractually, CAO's liquidation will be the end of the
story. But if its holding company uses this technicality
to dodge negotiations with creditors, the fallout will
further taint China's companies engaged in overseas
business and listed in foreign exchanges, dampening
investor enthusiasm in purchasing a piece of the China
action and throwing more doubt on the Chinese
government's credibility. For, at the end of the line,
it is the central government that is the final owner of
China Aviation.
How does the prospect of
recovery look for such creditors as Goldman Sachs,
Barclays Capital, Standard Bank, Mitsui Co and Temask?
Not very optimistic, if the past is any guide. China's
first huge corporate collapse occurred in January 1997
when the State Council "closed down" China National
Agriculture Development & Trust Investment Co. The
quasi-financial state-owned company chalked up an
operating loss of 5 billion yuan ($604 million) on top
of another 12.2 billion yuan debt that it had no hope of
ever repaying. The government reached into its own
pocket and paid off most of the creditors.
Then
another financial scandal hit. In January 1999,
Guangdong International Trust and Investment Co (GITIC)
was crushed by mismanagement and corruption that
incurred a mind-boggling debt of 14.4 billion yuan.
Unwilling to keep picking up the bill for the black
sheep any longer, Beijing changed tactics, ordering
GITIC to file for bankruptcy in a move it white-washed
as "respecting the rule of law". The liquidation of the
failed company left overseas creditors - mostly European
banks - in a state of disbelief and anger. But there
wasn't a thing they could do. Fielding a question from
an international news agency on different treatments for
CADTIC and GITIC, the then premier Zhu Rongji gave
advice that sounded more like a warning: "Pushing them
is not good for your own interest."
The banks
should have engraved his words in marble as most Chinese
companies have overstepped their authority in business
dealings and borrowings. Beijing has long set down rules
prohibiting state-owned companies from trading in
overseas futures and derivatives, except for hedging
purposes. Speculation is strictly and specifically
banned. But apparently that didn't deter CAO. Moreover,
the banks somehow convinced themselves that they'd make
more money doing in China - and with China - as the
Chinese do. So they circumvented their own rules and
released liberal amounts of loans on account of the
borrowers' "connections and background", only to see
Beijing cutting off all ties when the fall came.
In the midst of this crisis is some black humor,
too. The Securities Investors Association Singapore
awarded CAO a runner-up prize as the Most Transparent
Company in 2004. Sounded like an echo to an article in
the November 2003 issue of the Chinese Communist Party
magazine Seeking Truth, which praised CAO as the "pawn
in the strategic chessboard". The piece went on to say
that CAO was "an example of success stories about
Chinese enterprises going abroad to operate in the
international arena. Its experience is well worth
summarizing and recommending".
Indeed.
Li YongYan is an analyst of Chinese
finance, political and social trends.
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