Chinese State-owned enterprises (SOEs) may unilaterally terminate derivative contracts with six foreign banks that provide over-the-counter commodity hedging services, Chinese business magazine Caijing reported, citing unnamed sources.

The report said that the State-owned Assets Supervision and Administration Commission (SASAC), China's SOE watchdog, has informed the financial institutions in written letters that SOEs reserved the right to default on those derivative contracts.

Air China, China Eastern and shipping giant COSCO -- among the Chinese SOEs mired in huge derivatives losses since late last year -- have issued letters to banks, Reuters reported yesterday, citing a Singapore-based bank source, who said he had heard of the letters and that they were all in the same format. However, no bank name was mentioned in the report.

The Caijing report, quoting an unidentified SASAC official, said that almost every SOE involved in foreign exchange or trade had some exposure to derivatives such as crude oil, non-ferrous metals, agricultural commodities, iron ore and coal, although only 31 SOEs were licensed to do so.

"If we were among the banks receiving that letter, we would be very angry. But now the key is to find out more details about the letter: In whose name the letter was issued, government or corporate? And under what reasons for possible defaults?" a Singapore-based marketing executive with a foreign bank said in an interview with Reuters.

But Fan Haibo, an analyst from China Cinda Securities, told China Daily that these contracts sold by foreign banks to SOEs could be illegal.

"Those contracts sold by foreign banks could be without the regulators' approval, or some foreign banks may not possess the necessary qualifications to conduct the business," Fan said.

"That is the only explanation if SASAC really sent out letters," said the analyst.

SASAC took over the job of overseeing SOEs' derivatives trading from the securities regulator in February after several Chinese firms reported huge losses from derivatives. It quickly tightened the rules, ordering firms to quit risky contracts and report their positions on a quarterly basis.

In January, Air China, Shanghai Airlines and China Eastern reported book losses of almost US$2 billion on aviation fuel hedging contracts, Xinhua news agency said at the time.

In March, SASAC ordered that SOEs must review their futures, options, forwards and swap contracts in overseas markets and quit those with high risks. SOEs must overhaul their existing derivative investments, including investments through banks, and re-assess the risks of these products.

"Any form of speculative trading must be banned," the agency said.

"Financial derivatives are a double-edged sword, and any misuse could result in huge losses for companies."

(China Daily September 1, 2009)