By Francis Kan –
A day after its dramatic implosion under almost a billion dollars of losses, the collapse of China Aviation Oil is being compared with the two biggest failures in local corporate history: Barings Bank in 1994 and Pan-Electric Industries in 1985.
The crash of those two entities sent shockwaves throughout the financial industry, resulting in companies going bankrupt, executives being arrested, scores of people losing their life savings and even a few suicides.
When the dust had cleared in the Pan-El saga — which saw the company splinter under $450 million of debt — more than 30 banks had been hit, and a handful of stock broking houses were either sold or went belly-up. Two Pan-El directors were jailed for their role in the debacle.
In Barings’ case, the infamous rogue trader Nick Leeson single-handedly brought down Britain’s oldest merchant bank when he chalked up US$1.2 billion in trading losses. Leeson was arrested in Frankfurt after a manhunt, and imprisoned for five years here.
But beyond the immediate carnage, the landmark changes made as a direct result of these two incidents have led to the strengthening of our financial system, and played a great part in shaping today’s regulatory landscape.
Financial institutions are now better capitalised and supervised following Pan-El, while greater powers were handed to Singapore’s derivatives exchange (now a part of the Singapore Exchange) after Barings.
So what will CAO’s legacy be? Will this latest episode lead to a new round of regulatory soul searching? Or is this, as the Singapore Exchange claims, an isolated incident that is devoid of systemic ramifications?
It is probably too early to decipher the long-term impact of CAO’s collapse. After all, the authorities have to find out how this mess came about in the first place, before deciding on what should be done about it.
But already, some parties are calling for changes. The loudest cries have come from investors bemoaning the lack of transparency among China companies listed here.
David Gerald, head of the Securities Investors Association (Singapore), believes the CAO crisis “raises serious concerns about corporate governance in Chinese companies”.
The worry is that CAO-like time bombs could be ticking away among the 60 odd China-linked stocks on the local bourse.
The SGX will face pressure to defend its aggressive wooing of foreign companies to offer their shares here. Transparency issues at another China listing, New Lakeside, is likely to add to the pressure.
Another serious issue resulting from CAO’s collapse is the regulatory treatment of derivatives trading. These complex instruments — contracts whose value is tied to a stock or commodity — were also the root cause of Barings’ downfall.
But while it was Nick Leeson’s job to trade in these high-risk securities, CAO’s main activity is supplying jet fuel to airports in China. It had started out using derivatives known as oil swaps for hedging purposes, a legitimate tactic to fend off price fluctuations. But in 2003, CAO began to trade them for purely speculative reasons.
Market players told TODAY that CAO had bet that oil prices would be hovering around the US$30 mark in the fourth quarter of 2004. When prices went skyward and hit US$55 in October instead, the game was up and CAO was forced to realise its losses.
Their high-risk gamble is expected to cost them a mind-boggling US$550 million ($900 million).
Unlike shares and other types of derivatives, oil swaps are not regulated by an exchange like the SGX.
As such, there is little way for the market to know the full extent of a company’s exposure to these instruments until losses or profits are realised.
This explains why just days before CAO bared all, analysts covering the company had no inkling of the shocker to come.
Some changes are already in the works. After a four-year delay, new accounting standards, set to kick in next year, will require companies to report derivatives at their market value.
This will certainly help to some extent, but considering its high-risk nature, perhaps more can be done to monitor companies’ exposure to these instruments.
With Singapore making great strides in corporate governance, companies should no longer be permitted to engage in activities that fly under the supervisory radar.
Changes to address these problems could well become the lasting legacy of Singapore’s latest high-profile corporate failure.
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Source: Channel News Asia
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