Time for transparency

The storm at China Aviation Oil (CAO) rumbles on, four months after the Singaporelisted firm – supplier of most of China’s jet fuel imports – revealed it had lost $550 million in oil derivatives trading. In the latest instalment, CAO filed a suit with the Singapore High Court in March alleging that a restructuring of its options portfolio by Goldman Sachs in January and June last year actually amplified the company’s losses. Goldman, the firm alleges in an affidavit, failed to properly explain the risks posed by the restructuring, and in particular the use of extendible collars, resulting in enhanced market risk in the firm’s options book.

Whether the case has any merits or, as some bankers privately suggest, the lawsuit is merely posturing by CAO in the face of court proceedings from its own creditors is not yet clear (see page 11). However, the latest chapter once again highlights the lack of transparency around the CAO’s losses. Only sketchy details of its trading positions and the subsequent restructurings have emerged through court documents and, more recently, through consultants PricewaterhouseCoopers (PwC), whose investigation into the circumstances leading up to the losses was publicly released by CAO just as Risk was going to press. However, little has been said about the role played by CAO’s senior management or its parent company, the Chinese government-owned China Aviation Oil Holdings Company (CAOHC).

Compare that with the A$360 million forex options losses at National Australia Bank last year. Within three months, the Australian bank had published in full an investigation by PwC into the rogue trading scandal, as well as a separate report by the country’s banking regulator, the Australian Prudential Regulation Authority. The chairman and chief executive both stood down, and four of the bank’s former forex options traders are now facing criminal convictions (see page 9).

In the case of CAO, the PwC report highlights catastrophic failures in risk management policies and procedures, including the use of an incorrect valuation methodology for the mark-to-market calculation of its options portfolio. But little has been said about what is potentially the most damaging aspect of the case – the role played by CAOHC.

According to an affidavit filed by CAO chief executive Chen Jiulin last November, the parent company knew of the losses in October 2004 and sold $118 million worth of its CAO stock to institutional investors to raise money for the CAO’s margin payments. If true, that’s a pretty clear example of insider trading. Yet four months on, virtually nothing has been done – publicly at least – about Chen’s allegations, despite an initial pledge by the Singapore authorities to leave no stone unturned in its investigations.

China represents a huge opportunity for foreign firms, and it’s understandable that no-one wants to rock the boat. However, Chinese firms need to improve transparency, risk management and disclosure, and a good way to start is for the investigation into CAO to be made more transparent and for state-owned COAHC’s role in the share placement to be questioned.